Product price is one of the four Ps of the marketing mix, along with product, promotion, and place. Whiles product, promotion, and place are all cost activities to the firm, the price is the only component that generates revenue. However, the determination of product price is influenced by these other components. Other factors that influence product price includes competition, market conditions, brand, and quality.
It is, therefore, important for firms to correctly set their product price as it affects the sales volume. If the business managers get their pricing strategy wrong, it may create problems that could threaten the existence of the firm.
Setting product price, is probably one of the toughest thing many small business will take. It’s part art and part science.
Though the strategies can be complex, the basic rules of product pricing are straightforward:
- All prices must cover costs and profits.
- The most effective way to lower prices is to lower costs.
- Review prices frequently to assure that they reflect the dynamics of cost, market demand, response to the competition, and profit objectives.
- Prices must be established to assure sales.
8 Steps to Price your Product
If you asked customers to pay too much for your product or service and they will stop buying and if asked too little, your profit margin erodes or some customers will assume that your product is poor quality. Then, what steps can small business follow to price their products and services? Don’t be confused, as we have identified 8 key steps to set up an “optimum product price” that factors in all your costs and maximises your margins while remaining attractive to customers. Here’s how to set it.
1. Set your pricing objective
The strategic pricing objective should reflect what the firm hopes to accomplish with the product in its target market. When the business strategy and the target market for the product are all clearly defined, then formulating objectives and policies for the marketing mix, including price can be relatively simple. Pricing objectives of any firm may include the following:
- Maximise sale growth
- Maintain quality or service differentiation
- Maximise current profits
- Social – Offering a low price to the customers
2. Estimate demand and price elasticity of demand
You should be able to estimate the demand for the product in the market. Market demand sets the ceiling on the range of feasible prices for a product. Even before that ceiling is reached, however, the total number of customers willing to buy during a given period varies according to the price charged. Normally the higher the price, the fewer people want to buy. You should also note that some customers use price as an indicator of the prestige or quality.
3. Determine product cost and their relationship to volume
The product demand and perceived value are the two key factors that set the price ceiling a firm might charge for a product. However, the cost of producing the product determines the price floor.
Managers should, therefore, determine the cost developing the product or service before setting the price. There are two major types of cost for product pricing purpose. These are the variable cost and fixed cost. The sum of the two gives the total product cost. Variable costs would include materials, labour, packaging and so on; the more you make or sell, the higher these will be. Fixed cost will include rent, rate, wages, distribution, other marketing mixes etc. The set product price must cover this total cost figure – divided by the number of units produced – if it is to be economically viable in the long run.
Thus, price setting for a product cannot occur in isolation. It requires considering the costs of material, labour, overhead and the planned overall marketing mix for the product, including promotion, and distribution decisions.
4. Examine the Competition
You need to find out how much your competitors charge for a similar product. You can then decide whether to match or beat them. Simply matching a price is dangerous, though — you need to be sure all direct costs will be covered and that there’s enough contribution left to cover the indirect costs, which are mostly fixed. The product price of competitors should be examined with service and quality.
To successfully implement a low-cost strategy, for instance, the manager must be sure that the product’s costs are truly lower than any competitor’s and that those lower costs are reflected in the product’s relative price.
5. Select the product price Models
There are a number of pricing models which business can adapt based on the sector and the product. Managers can adapt a mix of these models as well.
5.1 Cost-based Pricing:
Cost-based pricing only considers the costs needed to produce the product and the desired profit margin. There are many ways to calculate cost-based pricing, but all of them are based on costs and include a markup for profit. For example, if the cost to produce a product is D5.00, and the company needs a 20 percent profit margin, the price will be set at D6.00 Industry norms, experience or market knowledge will help you decide markup as it varies across sector and product. If the price looks too high, you could trim your costs and reduce the price accordingly.
This method is convenient and easy, but it doesn’t consider elasticity of demand and competitors pricing method. It is not good for the competitive market. It also works on the assumption you will sell all units. If you don’t, your profit is lower.
5.2 Value-based Pricing
This method is also called Customer-based pricing. In this, the firm first analyses the customers to understand what they may be willing to pay for a product or service for the transaction to be profitable. The firm then charges the price each customer is willing to bear. A consulting business is a good example of the use of customer-based pricing, where a set price may be negotiated by the buyer.
5.3 The value in use
This method is similar to value-based, however, it tries to make a comparison with a similar product the customer is currently using or major competitors’ product (referent product). The objective is to present the incremental benefits of using the firm’s product which may include improved performance, additional features, efficiency or reduced cost over lifetime
You’ll need to know your market well to set a value-based pricing or value in use pricing.
5.4 Competition-based Pricing
In the competition-based pricing model, prices are set using the price of the competitors’ products. This model is used in industries with one or two dominant companies. Sometimes this model is referred to as “follow the leader.”
6. Set a price level
Considering the various pricing models and objective, you can now decide which approach is most suitable for your products after making the calculation and analysis. Do not ignore the customer and competition.
7. Adapt price structure to meet variations.
The final step in the pricing process is usually to develop a price structure that adapts the price to variations in cost and demand across geographic territories, national boundaries, types of customers, and items within the product line. For example, a cinema centre could charge a price for normal view at D100 per movie whiles VIP could be D150 per movie. All you know, they are watching the same movie but the ambience and convenient would be different. A similar method is applied in the bigger industries like the airlines.
8. Keep up to date
Due to the changing market condition, prices can seldom be fixed for long. Your costs, customers and competitors can change, so you will have to shift your product price to keep up with the market.
Keep an eye on what’s going on and talk to your customers regularly to make sure your prices remain optimal.
So Which Product Pricing Method is better?
Well, the answer depends on the other marketing mix, however, it is better to use a combination of different pricing methods, which means you mix elements of cost-based, customer-based, and competitor-based.
To set the right product price, you need to consider your costs and perform research on your target customers and competitors. Whatever method you adopt, you must ensure that you are covering your costs and the set product price are acceptable to customers. Sometimes, you may have to lower your product price via discounts and promotions, sometimes you may have to provide value-added services to ensure increase sales.