Price is the fourth leg of the classic 4 Ps. It’s also considered the last leg, because price strategy is usually the least understood and least documented in comparison with the other three.
The cause is, among other things, that there is no clear picture of what a price strategy is, and the terms strategy, price model, price level and price positioning are often mixed up. Below we have disclosed the most important topics to consider in creating a price strategy.
Main considerations for a price strategy
A price strategy is often thought of as (a) a decision-making of the desired market position and (b) how to price your own products in comparison to those of the competition. The product is then priced based on those considerations. These two elements are far from exhaustive and will inevitably leave large constraints on the specific prices. It is also the reason why many companies deal with endless discussions about pricing.
When determining a price strategy, the considerations should be expanded to include:
- Clarification of volume versus target earnings
- The audiences’ willingness to pay
- Decision on price differentiation and transparency
- What brand positioning do you want?
- Choice of pricing principles
- Decision on price model
Other segments of pricing are related to either the specific pricing or the daily transactional price handling.
Clarification of price strategy goals
One of the most commonly asked questions, a question that for most companies ends up in complete guesswork, is the balance between volume and earnings and the company’s ambitions for growth.
- If we choose a price of kr. 1000,- how does that effect volume, compared to a price of kr. 800,-?
The contribution margin will of course be lesser with the latter choice, and the question is, will volume be that much higher that a scale synergy is achieved, or will it simply create more sales, so that the total earnings are at least maximised? With a product margin of 40% a decrease in price of 10% demands a 33% increase in sales to maintain total earnings. It is imperative that all involved in setting a price strategy are completely aware of these correlations.
In most markets different price segments apply and price sensitivity vary among them. Instead of going with a gut-feeling, a thorough price analysis uncovering price elasticity should be made. As an alternative, many pose questions to their sales organisation, which is a poor solution for several reasons. The answers received will be coloured by what the sales organisation is usually measured on, primarily volume, and they are influenced by consumers constant notion of prices being too high. In our experience this is shear negotiating technique on the consumers part and price sensitivity more often is not that distinct.
Value based price strategy
Traditionally cost+ or competition-based principles have been the basis of pricing. Value based pricing is a new thing and has been rapidly increasing in more recent years. Any Price Consultant will apply this principle and that includes Contribution.
In all simplicity, the price must reflect the value the consumer receives from the product. Unfortunately, it is not as simple as that. In some cases, a factual value can be calculated, e.g. time consumption or processing effectiveness and at times also additional sales. In other cases, it is not a factual value but the client’s experienced value. Within B2B that may include prestige, quality of life and in B2C mean lesser internal struggles / more trust when choosing a known supplier.
The character of the product determines how mapping is most effectively done, all though the method often includes customer interviews of both the qualitative and quantitative kind. Even though some effort is needed, the value of the knowledge and facts to support pricing, when they need to be communicated and founded make it worthwhile. Besides, it enhances value proposition.
It’s a well-known fact, that price is of psychological importance when it comes to brand and product perception and a higher price than that of the competition is often interpreted by clients to be a quality indicator.
These factors are part of the market positioning you choose. At times, one can be tempted by a better margin and move further up market than your product entitles. Especially within B2B it is essential in the long run that quality is perceived to match the price. The mechanisms are not necessarily the same in B2C, where two products may be relatively similar both in look and quality and still be subject to significant price differences explained by marketing/branding.
Price differentiation and transparency
The degree of differentiation to the competition and the market’s transparency is often a slighted discussion in relation to price strategy.
- As market leader it is typically a good idea to reduce price transparency and create a significant degree of price differentiation to the different segments/markets, which makes it more difficult for both competitors and consumers to see through the pricing context without it having a negative effect on clients, as the position as market leader automatically brings credibility.
- As market challenger or new provider, it is more common to do the opposite and let pricing be as transparent as possible. The customers get a sense of simplicity when they buy the product and experience a reduced risk and increased trust, which is essential to inspire in potential clients for any new company.
Find the right pricing model for your price strategy
The final point of your price strategy is to determine which pricing model best capitalises the consumer’s value. There are different variations, typically within:
- Flat rate, usage-based or a combination of the two.
In relation to some markets the price model is a given, nonetheless it is always worth considering if you should follow the used models or find new ways with e.g. one of the many variations of the three basic models.
For years the most common pricing model has been flat rate. The client’s up-front investment is relatively high and in return there is no current payment to apply. Affluent clients would usually prefer making purchases based on flat rate as it is cheaper in the long run.
The usage-based model generates the biggest return over time if put together correctly, although if the product to be placed on the market is for example capital equipment then a usage-based price strategy can be hard to manage.
Depending on the client type, the perception of the product’s value can differ, something a price strategy naturally should reflect. The usage-based price model is a solution, although other pricing models could possibly be used for client groups or the price strategy should be anchored in a product de-bundling in which the basic product is reduced and in return more add-ons are featured.
Thus, the pricing model demands serious considerations and the core elements mentioned here should be a natural part of a price strategy in its entirety.
In need of assistance with this process please contact Contribution. We offer in-dept workshops to bring you to target.