How much should I charge for my product or service?
Knowing how much to charge is critical for a new businesses or businesses introducing a new product. Even existing marketing strategies call for periodic review of current pricing structures. Unfortunately, this isn’t an easy question to answer.
Pricing is a huge element of your marketing strategy as it determines how much of your product consumers buy and how much your firm makes. Pricing reflects on your brand — its a major driver of brand image (think Rolex and how its price adds to its appeal). Commonly, rather than looking at price, consumers use value — the excess of benefits over price — to determine which products to purchase.
1. Meet the competition
This strategy is simple and easy. You collect information regarding what your competitors are charging and make pricing decisions to match what competitors are charging. This marketing strategy is commonly employed for commodity type product where differentiation is not extensive — for instance in pricing gas. Since consumer loyalty to these products is low, and consumers see products as good substitutes, charging a premium price would decrease sales substantially. Commodity-type products commonly display high elasticity of demand — meaning a small increase in price can lead to a larger decrease in sales (see graphic above).
Elasticity of Demand is derived from the percentage change in quantity (%ΔQd) and percentage change in price (%ΔP).
2. Maximize ROI (Return on Investment)
Alternatively, firms might want to make the most return they can from their products. This marketing strategy works best when consumers have some incentive to buy your products over those of your competitors.
This notion underscores marketing strategy’s emphasis on non-pricing factors in framing competition. In other words, you should compete of quality, value, availability, or other benefits consumers might find in your products as it allows you to differentiate your products from your competitors and gives consumers a reason to not only buy your products, but to pay a premium price for them.
Maximizing ROI often requires knowledge of what consumers are willing to pay for your product. A useful tool to guide you in determining willingness to pay is conjoint analysis. Conjoint analysis is a market research technique using primary consumer data to determine the value consumers assign to various features of a product and the trade-offs they are willing to obtain one feature over another.
Although commonly used as part of the innovation process to determine which features to build into a product, conjoint analysis might be used to build your price based on the trade-offs consumers will make to obtain its features or to compare your product and its features against competitors to determine how your price should be set relative to these competitors.
While conjoint analysis is somewhat complicated and has to be tweaked to use in price setting, its probably preferable to asking consumer what they’re willing to pay for something. I was involved in a feasibility project for an aquarium where we asked individuals in our target market a number of questions including how much they would be willing to pay for admission. This was used along with forecasts of attendance as part of the feasibility study necessary to obtain funds. Unfortunately, stating a price preference is VERY different from actually reaching into your pocket and using a price somewhat lower than the average from respondents, forecasts were significant less than projected.
3. Targeted ROI
Targeted ROI is a marketing strategy using Breakeven analysis with a built-in desired profit.
Breakeven analysis is a powerful tool that can be used in this context, in sensitivity analysis, and is the backbone of many business decisions. Breakeven analysis uses the contribution margin (selling price – variable cost (like raw materials and production wages) along with fixed costs (like rent and insurance) to determine how many units of product must be sold. At breakeven the company neither makes any money nor looses money.
The formula for breakeven is:
Fixed Costs/ (Selling Price – Variable Costs)
when used to reach a targeted ROI this formula is modified as:
(Fixed Costs + desired return)/ (Selling Price – Variable Costs)
You can’t just set price based on your pricing strategy. You need to consider what consumers want to spend on your product.
Economists (and accountants) like to think consumers want to spend the least amount possible for a product. That’s just not true.
Consumers want value and a high price is justified if they feel the product has superior attributes. Take an Apple product, for instance. Consumers pay a premium for the “coolness” factor in iPhone, iPads, and Macs. Sure, there are some interesting features on these products (I’m a huge Apple fan), but, objectively, the products just don’t justify the pricing.
Part of Apple’s premium price comes from the lack of alternatives. There’s just no substitute product that provides the same coolness factor. You just don’t brag to your friends about owning a Dell. Plus, Apple is innovative and often their products are first to market — meaning they have no competition.
Sometimes a very low price implies poor quality — remember the value signal inherent in pricing.
This is especially true for products consumers can’t judge objectively. For instance, jewelry, professional services, car repairs, restaurants, and many other products are hard to judge. We use price as a surrogate for quality and a low price often draws fewer customers, not more.
We welcome the opportunity to show you how we can make your marketing SIZZLE with our data-driven, results-oriented marketing strategies. Sign up for our FREE newsletter, get the 1st chapter of our book on digital marketing analytics – FREE, or contact us for more information on hiring us.
Hausman and Associates, the publisher of Hausman Marketing Letter, is a full service marketing agency operating at the intersection of marketing and digital media.