I recently met with several business owners who were seeking help with their company’s pricing strategy. One company sells consumer products, another market a b2b technology application, and another provides professional services. Although the industries, products and services and revenue models were different, each company was dealing with the same challenge—how to price their product or service competitively in the face of high inflation, rising interest rates, the residual effects of the pandemic, socio-demographic changes (working from home), global geopolitical instability, increased government regulations, rising raw material costs and energy prices and supply chain bottlenecks. It’s no wonder many business owners are left scratching their heads.
Defining our Terms
Price is an integral part of the marketing mix. Marketing has been defined as offering the right product, at the right time, in the right place, at the right price—or commonly referred to as the ‘4-P’s’ of marketing. Pricing strategy is simply a model or method used to establish the price for a product or service.
Setting up the right pricing strategy is important for various reasons. Customers generally want the best value for their money, and they will almost always make purchasing decisions based on the perceived value of your product or service. If the price of your product is too high, then people won’t be able to buy your product, which will result in lower sales, and less profit margin. On the other hand, if the price is too low, you may increase sales but have little profit to cover your variable costs and fixed expenses. Determining the right price for your product or service at the right time is so important that just a 1% improvement in pricing raises profits by 6% (McKinsey).
Another important concept to consider is price elasticity, which essentially involves the ratio of the percentage change in quantity demanded of a product to the percentage change in price. Products and services for which consumers have many options generally have elastic demand and are more sensitive to price changes, while products and services for which consumers have few alternatives are most often inelastic and are less sensitive to price changes. Knowing the elasticity for your products and industry can help reduce uncertainty when adjusting prices.
There are dozens of ways you can price your products, and some will work better than others—depending on the industry, business stage, position you occupy and current environment. Below are just ten of the more common pricing strategies:
Each of these strategies offers different advantages and downsides. At the very least, you must make sure your pricing strategy covers your costs and includes a margin for profit. In certain situations, more than one pricing strategy can be used. For example, when a company launches a new product in the marketplace, it might try market penetration pricing.
The Value Equation
When determining how to best price your products and services, consider the following:
- The current positioning of your products or services. Are they positioned as lowcost options, luxury offerings, or somewhere in the middle? The pricing of your products and services should be aligned with your brand positioning— the other p’s of the marketing mix.
- Your customers. How do your customers perceive your product or service, in terms of price and value? What is important to your customers in terms of price, quality and value? Will your regular customers tolerate change to the pricing model for your products and services?
- Your costs. What are your current and anticipated input or raw costs, variable costs and production or distribution costs to produce your product?
- Your competitors. How does your pricing compare with your competitors? Can you justify higher pricing based on the perceived quality or value of your product or service?
Paul Smith is Director of the ND SBDC Fargo & Southeast Center. The SBDC helps empower North Dakota entrepreneurs and small business owners to thrive by providing no-cost business advising services and training in a range of areas. In 2021, the program assisted 1,800 clients across the State. The Fargo and Southeast Center is located in the NDSU Research and Technology Park Incubator. For more information or to register for services, please visit ndsbdc.org.
Ask Your Customers
If you don’t know what your customers want in terms of price, quality, and value, and how they perceive your product or service compared to your competition’s, it may be time to do some market analysis. Find out how much your competitors are charging for the same or similar products or services and assess how your offering compares in terms of quality. While the internet can be helpful in gathering competitive market data, we strongly encourage clients to survey customers or best of all engage with them directly. Find out how they go about making purchasing decisions, and how important price is in their decision.
After you have made a change in pricing strategy, plan to monitor your sales. How do your sales compare to the previous period and to budget? Are your products moving? Is there more or less demand than anticipated? If you have too much supply and too little demand, your prices may be too high, and you may want to adjust them to keep your product moving. On the other hand, if demand is so great that you can’t keep up with the supply, this could mean prices are too low.
Having a sound pricing strategy is key to a sustainable, profitable business. Striking a balance between sustaining demand while maintaining margins can be tricky. A winning pricing strategy starts with understanding your customers’ needs and wants, how they make purchasing decisions and discovering what they are willing to pay for your products or services based on their perceived value relative to the alternatives.
If you have questions or would like assistance in starting, managing or growing your business, please seek help from the ND Small Business Development Centers (SBDC), or another SBA resource partner.