Pricing Principles – The Ultimate Asymmetric Tool

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.
 
Over the years I have been amazed at the lack of understanding of the principles of pricing by companies of all sizes. Let's take a look at them here.

Pricing Principles

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.
Cost-Plus Pricing Diagram

Competitive Pricing

Competitive pricing uses competitors' pricing as a benchmark and then pricing your product at or below that benchmark. 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 are relying 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.
Competitive Pricing Diagram

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.
 
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
Value Pricing Diagram
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.

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.
Example of Conjoint Analysis Task

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.

Asymmetric Marketing is a full-service strategy and marketing agency.  If you would like to speak with one of our leaders about how we can help your organization utilize these ideas, click here to set up a quick consultation at no cost or further obligation.  We look forward to helping you win in your battle to overcome asymmetric odds.

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Mark Hope

Mark A. Hope is the founder and CEO 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 866-607-3593 or by email at [email protected]

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