Pricing is a specialty topic in marketing—one with very few practitioners. You can get a doctorate in marketing (like I did) without ever taking a course on pricing. That’s because most marketing professors don’t know enough about the topic to be teaching it. There’s an annual pricing conference for academics and there are typically only 30 to 40 of us there each year—and that includes a number of professors from outside the United States.
Most people with specialized pricing skills are working in or have their own pricing consultancy. You can find me and the other pricing consultants at PricingSociety.com under their Pricing Experts Directory. Other pricing specialists work at very large companies and multinationals that can afford their own in-house pricing staff.
If you’re a new, small, or medium-sized company, this means there’s nobody who can give you the pricing help you need. Not unless you’ve got an extra $30–$250K you can afford for a consultant.
What can you do on your own? You can buy a book on pricing and hope to learn what you need from it. The best all-around book on pricing strategy is The Strategy and Tactics of Pricing by Nagle, Holden, and Zale. If you can take the time, I recommend it. I even use it when I teach pricing. However, it can be pretty rough going for a newbie. I was already a pricing specialist when I first read it, and it still took weeks of my time and most of my focus to process it. And it has an academic focus—which means it doesn’t give any of the quick answers business owners and marketers need.
Also, ask yourself what your goal is. Do you want to learn to become a pricing specialist? Or do you just want to price your products for maximum profit and then move on to the million other decisions you need to make?
Buying this book is a smart alternative. It won’t give you the all-around knowledge you’ll get from Nagle and Holden’s book. However, it will get you through your pricing decision in a day (if that’s all you have) or a week (if you can spare more time for a better decision). And it will leave you with a much better—more profitable—price than your competitors.
One of the biggest headaches you’ll get from a textbook on pricing—and also in blogs and articles on pricing that are, in my opinion, worthless—is they will tell you to create demand curves to capture the price elasticity of demand.
In normal English, that means you are to track how many units you can sell at different prices—so you can find the most optimal price. Well, duh! If you already know that you can sell 6.5 percent more units at price “A” and 4.3 percent more at price “B,” then your decision is easy. You just calculate the profits and total sales at each price and your decision is made for you.
Just one teeny problem with this: It’s worthless advice for almost everyone. You’d first need to:
Because you’ll not be able to do all the above, and will therefore cut corners trying, the data you come up with will likely be wrong. That means no matter how impressive your demand curve charts look, making pricing decisions on them would be ill advised.
Businesses that have been selling the same product for ages at lots of different prices might be able to create demand curves. But they would be comparing sales at price “A” six months ago versus sales at price “B” three months ago. I wouldn’t trust there’s been no change in product demand for price “A” in six months, and you shouldn’t either.
Forget demand curves! With this book you won’t need them.
There is some question as to whether cost-plus pricing or competitive pricing is the most prevalent.
Nagle and Holden (2002) say cost-plus pricing is the most prevalent. This strategy adds up your costs then tacks on an extra percentage of the total for profits. Use of this (generally terrible) strategy is often the result of the pricing decision being left to the finance department or to an entrepreneur who doesn’t understand pricing.
Noble and Gruca (1999) found competitive pricing was used by three times as many companies they studied as any other strategy. They define competitive pricing as trying to match or come in close to the prices of the competing products already on the market.
If you had to pick one of the two above, pick the second one. Match-your-competitors pricing will lose you less than cost-plus.
But why use either?
If your competitors are small to medium-sized companies, they’re likely using one of these false strategies already. So you can gain a substantial advantage over them by using better strategies. If your competitors are large companies, well, you’re already at a disadvantage. You don’t want to increase it!
What is cost-plus pricing? It is a price that includes your costs plus a fixed percentage (15 percent or 50 percent—whatever your target is) for profits. Example: You need to price a new product that costs you $85 for materials. You estimate it also needs to cover $15 of your overhead. So your total costs are $100. You want to make 15 percent profit, so you price this product at $115.
Sounds great, right? You cover your costs. You get a guaranteed 15 percent profit. What could be better?
Actually, almost any other pricing strategy is better. Cost-plus pricing should be used only when you sell custom products. If you build custom houses, then you need to use cost-plus pricing. Using this strategy for any other situation is throwing away money.
The “guaranteed” profit from cost-plus pricing can actually lose you money. You could be throwing away profits, or you could actually end up selling your products for lower than your costs! Here are the deadly duo of ways this strategy will hurt you:
Planning to match your competitors’ prices is recommended only in two, frankly unlikely, sets of circumstances:
Why are they unlikely?
This is not to say you ignore competitor prices. Not at all! They are a wonderful source of free research for you. Reviewing your competitors’ prices tells you what your target customers are willing to pay for products with some similarities to yours. You don’t have to guess they’re willing to pay those prices. Your competitors’ sales prove it!
The problem with pricing a new product relative to your competitors is that it doesn’t give you enough price “bonus” for your product’s advantages over the competitors. It also doesn’t account well for any negatives your product has relative to the competitors.
For example, suppose you create a new product that is 10 percent better than the competitors. What is that extra 10 percent of effectiveness worth to consumers? Maybe not a single penny more. Or maybe double or triple your competitors’ prices.
Want proof? Here are two examples:
The value of your new product has no basis in your costs or the degree of improvement over competitor products. The value to your customers is in the degree to which they want your new advantage.
Matching your competitors’ prices doesn’t capture the true value to consumers of your product’s specific benefits. Nor does it recognize your product’s disadvantages compared to competitors.
Both of these can cause the value of your product or service to differ substantially from your competitors. So matching competitor prices could lose you the price premium you could have commanded (because you are underpriced for the value you deliver) and/or lose you substantial unit sales because you’re overpriced for your perceived value.
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