April 06, 2009

Pricing is a blend of art and science

Many managers struggle with the issue of price.  That means they are leaving money on the table.  The ability to justify, negotiate and command high margins and prices is the supreme test of salesmanship, as well as the most meaningful measure of quality.

1. Why Managers Struggle To Get The Price Right

Pricing is a blend of art and science.  For economists it is a relatively straight-forward equation – that point where demand and supply meet.  But in the real world how prices are set is much more complex.  That is why it cases problems for managers.

 Price is only one half of the price-value equation, albeit the half that tends to get most attention.  A product, or solution that is 50% more expensive, but delivers a 20% saving year on year over and above others solutions is still the best solution to buy.  Hence, the increasing focus on pay-back, or return on investment.

Even for rational buyers and economic buying decisions price involves the notion of psychology and perception Products and services that may be relatively similar in terms of form and function can have vast differences in price depending on brand name, styling and other quite subjective factors.  Indeed, a whole array of difficult to weight factors, from the reputation of the company to the relationship with the salesperson, can outweigh price. 

Part of the reason for the difficulty in setting price, is the fact that there are few absolute rules ot follow and several paradoxes, for example:

      ·         For some products raising the price perversely increases demand, or at least desirability. 

      ·         Price is relative and increasing it can be effectively achieved by reducing the volume of the product, the length of service, etc.

2. Pricing: Key Questions to Address  

Here are some of the key questions Managers should address in setting, or revising price:

1.       (a) What is the cost?  That is what do you need to charge to cover the cost of producing and delivering the product/service, as well as the cost of its development and marketing? 


·         To avoid under-estimating the cost of marketing, take the cost of development and multiply it by 3.

·         Calculate the total cost of development and taking your product, or service to market, adding up all direct and indirect costs.  Spread this over different estimates of volumes to be sold.

·         Of course, to that needs to be added a profit margin representing the return on investment and reward for risk to the promoters.

2.       (b) What is the customer willing to pay?  The answer to this question is based on an understanding of the value and the payback of you solution.

(i)    Understanding the value

What are the factors that determine the perceived value of the solution?  Break your product/solution into components (e.g. scoping, pilot, installation, integration, commissioning, ongoing support, etc.) and, where possible, isolate the benefits/value associated with each.  Re-arranging these components can impact on the value.  

In terms of market research report they may put little value on the research process and reporting, but great value on the conclusions and recommendations.  So it would make sense to increase one and perhaps reduce the other.  Can you separate out different elements and charge for them separately (e.g. service)?


·         Keep in mind that price sensitivity, perceived need (or urgency) and value for money of your solution will vary greatly from segment to segment. 

·         It can also vary according to how you position your solution and the promises, benefits, or features that you highlight.

 (ii)   Understanding the payback

How significant is the problem that the solution solves?  What is the payback, or return on investment for the customer?  What saving, or additional revenues will ultimately result from the solution?   What is the customers total cost of ownership?  What proportion of that total cost does the price account for?


·         Create a spreadsheet to calculate the implication of your products, or services on the customer’s business.

·         Involve the customer in modeling the business case / return on investment for your solution.
It is generally best to be modest, or realistic in your assumptions.

·         Track how customers apply and benefit from your solutions.  Undertake a before and after analysis of the impact.


3.       (c) What are competitors charging?  What do the alternatives cost?  



·         Keep the list of alternatives as broad as possible, including the cost of alternative technologies, or solutions and even the cost of doing nothing.


·         Do you start with a low price to penetrate the market and then increase?

·         Do you have a higher list price, but be prepared to negotiate?

·         Do you offer a number of product variations/service alternatives with different prices attached to each?

·         Do you charge for your solution in terms of a large upfront payment, or alternatively in smaller increments?  Do you charge once-off or per usage / ongoing license / retainer fee? 

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