Pricing Management

From Virbus

[edit] 1 HOW DO YOU BUILD A PRICING STRATEGY AND CHOOSE THE CORRECT METHOD FOR YOUR PARTICULAR BUSINESS SITUATION?

• It's important to know your competitors’ prices and the willingness of your customers to pay.

• Sometimes, but not always, information on pricing frameworks can be obtained just by asking. Seek and utilize all public and commercial sources of pricing information available. Use them properly at your own discretion.

• It's probably unwise to raise or lower your prices significantly without a good reason. Both extremes will hurt your business leading to losses in profits or customers.
• The perception of your product or service (i.e. brand value) is also important. In many markets, a high price contributes to the perception of your product as being of premium value. Desired perception is created by correct marketing activities in which the pricing message plays a vital role.

• It can be useful to charge different prices for different customer segments in different sales/distribution channels at different stages of the buying process (i.e. price points).

• In relation to quality of service offered vs. related cost needed for such a service to take place, providers need to take into account end–result/cost-benefit when pricing (Note: customers who are expensive to satisfy might be less profitable and even erode profits - unless you apply price premiums to them .

• Whatever prices you set, check that they cover your costs and can deliver a profit in order to enable you to develop and grow your business on a long term basis.

[edit] 2 Pricing Methods

To set the specific price level that achieves their pricing objectives, managers may make use of several pricing methods as explained in the following sections

(1) Cost Plus Pricing

(2) Market Based Pricing

(3) Value Based Pricing

[edit] 2.1 Cost-Plus Pricing

Cost-Plus Pricing - setting the price at the production cost plus a certain profit margin. That Cost-Plus Pricing is a price increment that is added to the cost of providing the product or service. The mark-up provides the profit margin.

Cost-plus price is based upon a mark-up on the cost of an item. This method is extended to specific customers for specific price classes only. The mark-up percentage may be set individually for each customer and for each price class for that customer.

Cost-plus pricing - works well when the buyer and seller don't know what the cost of production will be but agree on a target profit over and above the product cost.

Cost should always be the base for any pricing decision. Cost drivers are either measured or estimated and then covered by sales price + added margin. The main problems of a cost based pricing strategy are that cost variables are more or less time dependent and that volume will affect the unit price(-ing). The sales volume is also in correlated to pricing. (Richards, 2005).

Another difficulty is that the model is somewhat stiff and will not be easy to change when competitive circumstances require change. This could lead to prices that are too high or too low on the market. (I DON'T ENTIRELY UNDERSTAND THE LOGIC OF THE LAST SENTENCE SO MY CORRECTIONS ARE AN INTERPRETATION OF WHAT I THINK THE AUTHOR IS TRYING TO SAY)

Cost-plus pricing involves setting price by starting with the cost to provide a product or service and then adding a mark-up above the cost. The mark-up provides the company with its profit margin.

[edit] 2.1.1 Cost-Plus Pricing—Advantages and Disadvantages

The advantages of this type of pricing are:

• It is easy to apply because it's based on cost data.

• Mark-ups can be based on industry standards, individual expert opinions, or widely accepted rules of thumb.

• Cost-plus pricing almost guarantees that you will not sell at a loss, so a cost-plus figure generally provides a basis for the lowest price acceptable.

• You are not required to follow the ups and downs of prices in the market.

The disadvantages of cost-plus pricing are as follows:

• Businesses that cannot identify their costs accurately may set prices at a level that does not recover actual costs.

• Cost-plus pricing takes into account the cost and profit side of buying and selling, but it neglects demand.

• Cost figures are generally based on an assumption of sales/production numbers.

[edit] 2.2 Market-Based Pricing

Another method of setting the price is known as market pricing and is based on the results of your market research, which should tell you how much your potential customers are willing to pay for the product, or service.

In Market-Based pricing, the producer generally researches how much is usually paid for a certain product in the markets. This can be benchmarked by comparison. If this model is used, then the price elasticity of demand (for further information refer to elasticity theories) should be known.

Large and positive elasticity in the price/volume relationship indicates that reductions to the general price level can be made quite safely. If elasticity is negative, a price increase should be considered. On the other hand, plain willingness to pay is not enough if the potential customer base has no disposable assets or credit (also current liquidity) for the purchase. Thus, you need supporting data on specific and detailed markets as well as analyses of consumer purchasing behavior. (Richards ym. 2005)

Prices are based on the going rate for the product or service. The going rate is derived from two factors:

• What competitors are charging

• What customers are willing to pay

Different features to be considered in researching this method of pricing:

• Is your product more convenient to buy than the competitors?

• Are you selling when others are not?

• Is your product unique, or very rare?

• What is the marketing mix for your particular product/service and profile of your customer base?

[edit] 2.2.1 Market-Based Pricing—Advantages and Disadvantages

The advantages of market-based pricing include the following:

• It keeps you competitive with direct competitors in the eyes of your customers.

• It is relatively fast to develop since competitor price comparisons is at hand.

• Market-based pricing is easier for customers to understand.

• If the market price set by your competitors enables them to make a profit, your business should be able to make a profit at this price point as well.

The disadvantages of this pricing method include:

• The market price may not provide you with the profit margin you want.

• Market-based pricing generally does not take into account non-traditional competitors like niche-players and/or new entrants that offer potential substitutes for your product/service.

• Your business model may allow you to produce and sell a much greater volume of a particular product than your competitors can sell. Your product may be so new that there is no solid market-based price with which to compare your product or service.

• Market-based pricing requires that you track the market price (i.e. you need to have allocated resources with responsibility for this key critical task)

[edit] 2.3 Value-Based Pricing

Base the price on the effective value to the customer. The price is based on an estimate of the maximum perceived value of the product or service and the maximum price customers will pay. Value may be one of the most overused and misapplied terms in marketing and pricing today.

Value pricing is too often misused as a synonym for low pricing. The real essence of value revolves around the trade-off between the benefits an individual gets from a product/service vs. the price he pays for it, or more accurately the perceived benefits received and the perceived price paid. This causal relationship can be expressed with a simple equation:

Value = perceived benefits - perceived price. (Marn, Roegner, Zavada. 2004)

This focuses on the price you believe customers are willing to pay, based on the benefits your business offers them. Value-based pricing depends on the strength of the benefits you can prove you offer to customers. If you have clearly-defined benefits that give you an advantage over your competitors, you can charge according to the value you offer customers. While this approach can prove very profitable, it can alienate potential customers who are driven only by price and can also draw in new competitors. (Source : Businesslink web pages, October 2007)

How does value-based pricing work

A few value-based pricing strategies are listed below that take into account the break-even point, but are heavily weighted with subjective judgments.

• Price the same as competitors. This strategy is used when offering a commodity product, when prices are relatively well established (such as with professional services) or when you have no other means to set prices. Your challenge then becomes to determine how to lower your costs so you can produce a higher profit than your competitors.

• Establish a low price (compared to the competition) on a product in order to capture a large number of customers in that market. This strategy may also be used to achieve non-financial objectives such as product awareness, meeting the competition or establishing an image of being low-cost. It works if you are able to maintain profitability at the low price, or if you're able to maintain an acceptable level of sales should you later raise prices.

• If your product has a mystique and uniqueness that is valuable to customers, you might have the ability to charge a very high price premium relative to your cost. Also, if your target market is affluent and you are positioning your product as a "prestige" product, an especially high price could be in order.

[edit] 2.3.1 Value-Based Pricing — Advantages and Disadvantages

Value-based pricing is used less frequently than the previous two pricing strategies, but it offers some excellent opportunities for stabilizing or increasing your profit margins. In value-based pricing, price is based on an estimate of the maximum perceived value of your product or service and the maximum price customers will pay for it.

The advantages of value-based pricing are:

• It takes into account industry structure, segmentation, competitor pricing practices, and substitutes and alternatives, all of which can make pricing more coherent and complex.

• Value-based pricing can be the only way to price new products or "breakthrough" products.

• Pricing can be based on several customer-focused methods: expert opinion, customer surveys, price experiments (for example by using conjoint-analysis theories and techniques), and analysis of past, present and expected market data and conditions.

The disadvantages of value-based pricing include:

• It requires more data gathering and analysis than market-based or cost-plus approaches.

• The process for determining price is more complex than other approaches because it uses "soft" market data in addition to "hard" market data.

• Most methods used to gather data for this type of pricing are relatively specialized and require expertise to convert raw data to information to knowledge (i.e. needing adequate level of resources and systematic business intelligence and customer insight process in place). Thus, for small and mid-size companies difficult to do by themselves (outsourcing always a possibility.)

[edit] 3 Links/sources used as references

Marn, Roegner,Zawada. Wiley Finance 2004. The Price Advantage

Revenue Management and Pricing – Case Studies and Applications – Thomson Learning 2004 – Yeoman, McMahon-Beattie , Case The Right Price Consultants, Julie Swann s.32-45.

Richards, J. D., Reynolds, J., Hammerstein, M. (2005) The Neglected Art of Strategic Pricing. Financial Executive. Vol 21, pp. 26-29.

Business's Link 2007. http://www.businesslink.gov.uk. Dated 15.10.2007

Marketing teatcher 2000.www.marketingtatcher.com. Dated 15.10.2007

MBAn webpages 2007. www.netmba.com. Dated 15.10.2007