Pricing Principles

To compete against larger competitors with more resources, you must find strategies, tools, tactics, and processes that will help you level the playing field.

One of the least understood business concepts is pricing.

As the founder and Chief Operating Officer of a global growth agency, I have noted over the years the lack of understanding of the principles of pricing by companies of all sizes. Let's take a look at them here.

When considering pricing, there are three primary inputs:

1) The customer's ability and willingness to pay the price

2) Price levels of competing products

3) The company's own cost structure

There are three fundamental pricing principles:

Cost-Plus Pricing

Cost-plus pricing is the simplest and most common pricing principle. It entails taking the product cost (including material cost, labor cost, shipping, marketing, and overhead) and adding a percentage to it.

This method ensures that you are covering your cost and making a profit from your products, but it fails to consider the customer's point of view as well as the role competing products play in the marketplace.

As an example, let's say you are launching a line of custom widgets. You want to use cost-plus pricing to determine the best price to use in order to ensure that your new product is profitable.

The cost for your new widgets are:

Material costs: $6.00
Labor costs: $10.00
Shipping costs: $5.00
Marketing and overhead costs: $9.00

You decide to use a 50% markup, so your price is:

Cost ($30) x Markup (1.50) = Selling Price ($45.00)

Cost-plus pricing is easy to use, easy to calculate, and it provides consistent returns. However, this principle does not consider the customer's ability and willingness to pay or the price levels of competing products.

Competitive Pricing

Competitive pricing uses competitors' pricing as a benchmark and then pricing your product at or below that benchmark. Competitive intelligence can give additional insight into how to best employ this methodology. This principle implies that the competition has determined a reasonable price and the prices being used are being accepted by the marketplace.

This principle works best in industries with commoditized or highly similar products where the price is the primary driver for winning the sale. You rely on your price as the primary differentiator between your product and that of your competition.

Competitive pricing can be effective if you have lower-cost inputs or if you can negotiate better pricing from your suppliers. If you have an extremely cost-efficient business model, this may help you in employing competitive pricing.

This principle considers both the price level of competing products and the company's own costs, but it fails to adequately consider the customer's ability and willingness to pay the price.

Value Pricing

Value pricing sets the price based on what the customer thinks the product is worth. Companies that sell unique products are better positioned to take advantage of value pricing. For this to work, the company must have insights into how customers value the product. The buyer's point of view is the driving factor in successful implementation of value pricing.

Value pricing is considered the superior method for pricing products that can be differentiated on quality, features, benefits, or desirability. This principle considers all three inputs: the customer's ability and willingness to pay; the price levels of competing products; and the company's own cost structure. Your target audience may pay more for your product, but the value is not what your target audience will pay for. Value is created by the customers' perception about how benefits apply to them. You must have a clear understanding of how products create value for your customers. It is possible to see it in a practical way: instead of pricing the product, price the customer.

Usually, value pricing allows you to recognize higher prices and more profit from your products. It encourages good brand marketing, effective communication, and ongoing product innovation.

Tools that are necessary to win using value pricing include:

A well-developed and properly positioned brand
Great products that have unique benefits and features
Marketing campaigns that resonate with the target audience

A very simple formula for determining value pricing is to determine, from the customer's perspective, what benefit he gains from the product less the cost to get those benefits.

Value (V) = Benefits (B) - Cost (C)

However, this formula is too simplistic to employ in a truly competitive market. What we need to do is to combine value pricing with competitive pricing. We will not end up with value that is absolute, but rather relative to the other choices he may have. We'll call this Differential Value.

Differential value can be illustrated as:

Differential Value (dV) = Differential Benefits (dB) - Differential Cost (dC)

Differential benefits include both tangible and intangible benefits. For example, "easy to use," is an intangible benefit, whereas "maintenance-free," is a tangible benefit. Both are to be considered in determining differential value. Another important consideration is that of opportunity cost that may be avoided or saved.

Needless to say, for a customer to be willing to purchase a product using value pricing, the differential value must be positive. Otherwise, the benefits are worth less than the cost and the customer won't make the purchase. Thus:

Differential Value >= 0

Another name for this idea is Economic Value to Customer (EVC). The Economic Value to Customer (EVC) of an offer is the maximum achievable price for the customer to find the offer attractive.

Economic Value to Customer = Price a <= Price b + Differential Benefit

So, looking at the equation above, the highest price you can expect to achieve is the price of your nearest competitor plus the value advantage your product has over that competitor.

As an example, if my nearest competitor has a price of $500, my price to achieve EVC is $500 plus the value of any additional benefits that my product offers. Keep in mind that these additional benefits can be both tangible and intangible and my ability to communicate this value may significantly increase its value.

Price Structure

The price structure is designed to capture the most affordable price for each customer group. It is possible to optimize pricing in certain industries, such as airline companies that sell identical airplane seats with different conditions depending upon the customer's profile. It is difficult to create a segmented pricing structure that differs not only in the price but also in the offer and qualifying criteria. A few tools can help:

Bundles can be a powerful tool if you combine elements that would be more price-sensitive if they were sold individually. Bundling a low-priced service with other products can sometimes work better than simply lowering its price. Examples of this include low-cost financing, payment terms, and anything else that customers may not value as much. Bundling optional services for free is a bad idea unless the cost to deliver the service itself is very low.

Conjoint Analysis

One of the best tools to determine EVC in a statistically viable manner is the use of conjoint analysis. Conjoint analysis is a popular method of product and pricing research that explores preferences by customers.

It uses the information gathered in the research process to help determine product features, price sensitivity, potential market share, and to predict the acceptance of a product by the market.

Who Should Manage Pricing?

General management is ultimately responsible for the profitability of the enterprise, but the General Manager is usually not the person most in touch with the details that go into a proper pricing decision.

Value-Based Pricing is the most profit-maximizing strategy of all pricing strategies. To use Value-Based Pricing, the person pricing a product or service must understand the value the customer or customer segment derives from the product or service.

Also, the person must be able to understand and compare the market landscape, including the prices of competitors and their differentiating factors.

To ensure profitability, one must know how much money was spent on the product's construction.

There is only one person who understands all of these values and can put a dollar value on each of them. That is the Product Manager. Because of this level of insight, they should be responsible for pricing.

Aspiring PMs: Next time you use/purchase/see a product, question its value to you. Put a dollar value on it and verify that the return on your investment (ROI), meets your expectations. You can do the same thing with a competitor's product. Do some mental math to determine how much it would have cost to produce the product. Find out which product is right-priced and why.

The Bottom Line

The price you put on your products is a major determinant of your company's profitability and competitiveness.

To do pricing well, you must seek a pricing principle that is appropriate for your product and your market. Then you must perform research on your potential customer as well as your competition to determine how you can recognize the optimal amount of revenue from each unit sold.

Pricing is one of the most important attributes of your product. It communicates many things about your product, your brand, your company, and the value you purport to offer.

It is far too important to just wing it.

Use Pricing Principles in Your Business

Asymmetric, led by former Army Delta Force operator and corporate executive, Mark Hope, can help you implement these ideas in your business. You can contact Mark by email at mark.hope@asymmetric.pro, or by telephone at +1 866-389-4746, or you can schedule a complimentary strategy discussion by clicking here. You can read all of his articles on Medium.

Posted in Pricing, Strategy

Mark Hope

Mark A. Hope is a co-founder and Partner of Asymmetric Marketing – a unique agency specializing in building high-performing sales and marketing systems, campaigns, processes, and strategies for small businesses. Asymmetric has extensive experience with organizations across many industry segments. If you would like some help in implementing ideas like these in this article, feel free to give Mark a call at 844-494-6903 or by email at mark.hope@asymmetric.pro. Read Mark's other work on Medium.

Pricing Principles – The Ultimate Asymmetric Tool