Product Pricing Strategy

Pricing may be the most important decision that the entrepreneur makes. Often this decision is rushed and done by the seat of the pants. Most entrepreneurs think pricing is easy.

Many small businesses use mark-up pricing. Mark-up pricing uses some multiple of cost such as three or four times the “estimated cost”. The entrepreneur says, “If it costs a dollar to make the widget, I need to sell it for three or four dollars. Hey baby, we are living large!” Whoops! Look back a few words and you will see the word “estimated”; most entrepreneurs don’t know what their actual costs truly are. Often they under price their products since cost accounting at small firms is only the sum of direct materials and direct labor, if that.

Competitive pricing is even more scientific. Simply, you price your product or service to be just below competition or to match a competitor’s price. Why? Is the competitor down the street a pricing genius to be reckoned with? I think not. I guess this approach presumes that the competitor is the price leader and has educated all customers to this price. My guess is that the competitor may have used a crystal ball or had his cousin Vinny price his product. Fallible? You bet. This pricing method is used at large and small firms.

At a start up, first-time customers may deserve special pricing to compensate them for the risk of doing business with the new enterprise. So quote them two prices: charter or founder prices for today and a standard price or list price for a year from now, which they will ultimately have to pay. A weakness of this method is that once you give a price to a customer, it is very hard to raise prices after that. This approach is best used at the earliest introduction of a product or service for a start-up while you don’t have many customers. Be careful.

“Perceived value-based” pricing is pricing for a product or service at a level that reflects the potential savings, the highest satisfaction level, or the maximum use that a client will receive from the purchase and the use of the product or service. Overall, price is set at the highest level that your target market is willing to pay, given these benefits. This type of pricing reflects a sustainable competitive advantage where there is little or no competition. This is niche market heaven. However, be sure that your competitive advantage is real and defensible, or you have got trouble on the way. How much is too much to charge, when utilizing perceived value based pricing? Look for tearstains on the checks you receive from customers. If it hurts them to write you a check, then you are charging too much. If that is the case, you won’t keep them as customers for long.

“Skimming” refers to pricing a new product at a high level while you can. This is a market where a competitive advantage may not be sustainable. Most often, this is used in a market that is big enough to attract new competition. This happens a great deal in technology when an innovative product first captures the customer’s attention. One reason to set an initial high price is to establish the new product as a prestige or a high quality product; by beginning with a high price, you also have room to move down in price with the anticipated entrance of competition. This is not the pricing strategy for a niche player since a niche-pricing strategy is based on a sustainable competitive advantage and a partnership with the customer. An example of skimming would be the DVR (digital video recorder) product called TiVo, which has revolutionized watching television. Early on, this was a product for the early adopters and TiVo products commanded a premium price. Competition entered the market and prices softened. Soon all satellite receivers will have DVR features. Game over.

“Penetration” pricing is a tactic where a provider sells below market price to break into a market or to take market share. This is what the Japanese semiconductor makers did in the 1980’s; buoyed by a lower cost of capital and a government-sponsored long-term objective, taking market share from the U.S. semiconductor firms was the worth the short- term losses. You may recall that the U.S. manufacturers called foul on this practice and referred to it as “dumping”. Japan emerged as a major player in the semiconductor memory chip business and pushed many U.S. suppliers out of the business. This is a very interesting tactic, but hardly a tool for entrepreneurs like you and me.

“Economic or mass market” pricing is used when margins are slim, volumes are high, and there are many competitors. The best example of this may be in the grocery business. Economic pricing is highly elastic with slight pricing variances creating major swings in demand. This type of pricing does apply to a niche market and is not for us to be bothered with in this book. Sorry Safeway.

The point to remember is that cost is to value as fish are to bicycles (i.e., there is no real relationship). As a niche player with a sustainable competitive advantage, you always want to price your product or solution using a perceived value pricing methodology. If you cannot price in this fashion you are not a niche marketer.

John Bradley Jackson
© Copyright 2011

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