How do you go about your pricing strategy – setting the prices for your products and services? Do you price your product high to maximise your profits in the short term, or price more moderately to maximise your profits in the long term?
Should you aim to sell a low volume of products at a high price or a high volume at a low price?
Do you set your price by calculating your production costs and overheads and then marking them up to give your desired profit margin? Or do you set a target price and then design your product or service to meet that target?
There are a lot of variables to consider when setting your price, such as ‘what is the consumer demand for my product? What pricing strategies do my competitors use and how are they likely to react to different pricing strategies?’
SETTING A PRICING STRATEGY
It is important to understand that you need to price your products to maximise both sales AND profits, whilst providing enough margin to take care of promotion, distribution, production and overhead expenses. Let’s look at some different pricing strategies.
A survival strategy merely covers costs and allows a company to stay in business. It is a strategy that should only be used short-term strategy when companies are being hurt by severe competition or a change in consumer demand. Sadly, I see this survival strategy being used all too often – and not always out of necessity. It seems that many small/medium sized business owners are simply too afraid to price their product/service to ensure long term profitability.
Current Profit Maximisation
Companies using this strategy estimate the demand and costs to produce for a range of different prices and then choose the price that will give them the maximum current profit. This is very much a short-term strategy and risks inviting competition into the market.
Market Share Leadership
A company may feel that gaining the largest share of the market will lower costs and give the highest profit in the long run. So it sets its prices low in order to gain market share.
This strategy will only work if the market is price sensitive for a particular product and lower prices will lead to increased sales. It is extremely hard for a small/medium enterprise to corner this sort of market.
Product Quality Leadership
You can charge premium prices for a high-quality product; this relies on your customers perceiving your product as prestigious or high quality.
You need to consider the price sensitivity of your product. With some luxury goods, lowering price can actually lower demand. Why? Because what consumers are looking for in this case is something they perceive as being a high priced, prestige article.
Products usually differ in their price sensitivity. A distinctive product will be less price sensitive than one that has a lot of competitors. If a product is not distinctive, consumers will quite often go for a similar but cheaper product.
The relationship of product demand to price variation is known as price elasticity. If price changes have a big effect on demand, demand is said to be elastic. If price changes make little difference to demand, then demand is said to be inelastic.
SO WHAT PRICE SHOULD I CHARGE?
There are so many issues to consider when you are looking at what price you will charge. These are just a few.
Always remember you are in business to make a profit and so you must really give your pricing strategy careful consideration.
AND REMEMBER THIS…
…quite often the person who has the biggest problem with the prices you charge is YOU. Don’t be afraid to raise prices to keep your business viable.
About David Officen
David is the Founder and Managing Director of proCFO. David combines an accounting and consulting background with commercial experience both as a manager for large commercial businesses and as the owner of private and family businesses.