How much to charge for a product or service?
This question is a typical starting point for discussions about pricing, however, a better question for you to ask is - How much do customers value the products, services, and other intangibles that you provide? We already know that customers have a perceived benefit of your product or service, which may not be the same as yours.
Pricing involves asking questions such as:
- What are your pricing objectives?
- How to set the price?: (cost-plus pricing, demand based or value-based pricing, rate of return pricing, or competitor indexing)
- Should there be a single price or multiple pricing?
- Should there be quantity discounts?
- What prices are competitors charging?
- What image do you want the price to convey?
- Do price points already exist for the product category in the market?
- How flexible can we be in pricing? : The more competitive the industry, the less flexibility we have.
The price floor is determined by production factors like costs (often only variable costs are taken into account), economies of scale, marginal cost, and degree of operating leverage
The price ceiling is determined by demand factors like price elasticity and price points
- What is the chance of getting involved in a price war?
- How visible should the price be? - Should the price be neutral? (ie. not an important differentiating factor), should it be highly visible? (to help promote a low priced economy product, or to reinforce the prestige image of a quality product), or should it be hidden? (so as to allow marketers to generate interest in the product unhindered by price considerations.
- What sort of payments should be accepted? (cash, check, credit card, barter)
What a price should do
A well chosen price should do three things:
- achieve the financial goals of the company (e.g., profitability)
- fit the realities of the marketplace (Will customers buy at that price?)
- support a product's positioning and be consistent with the other variables in the marketing mix
price is influenced by the type of distribution channel used, the type of promotions used, and the quality of the product price will usually need to be relatively high if manufacturing is expensive, distribution is exclusive, and the product is supported by extensive advertising and promotional campaigns a low price can be a viable substitute for product quality, effective promotions, or an energetic selling effort by distributors
The 9 Laws of Price Sensitivity
In their book, "The Strategy and Tactics of Pricing", Thomas Nagle and Reed Holden outline 9 laws or factors that influence a buyer's price sensitivity with respect to a given purchase:
Reference Price Effect
Buyer´s price sensitivity for a given product increases the higher the product´s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
Difficult Comparison Effect
Buyers are less sensitive to the price of a known / more reputable product when they have difficulty comparing it to potential alternatives.
Switching Costs Effect
The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
Price-Quality Effect
Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.
Expenditure Effect
Buyers are more price sensitive when the expense accounts for a large percentage of buyers´ available income or budget.
End-Benefit Effect
The effect refers to the relationship a given purchase has to a larger overall benefit, and is divided into two parts: Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit.
Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit (e.g., think CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component's price.
Shared-cost Effect
The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
Fairness Effect
Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
The Framing Effect
Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.[3]
From a marketing point of view, an efficient price is a price that is very close to the maximum that customers are prepared to pay. A good pricing strategy would be the one which could balance between the price floor (the price below which the business ends up in losses) and the price ceiling (the price beyond which the business experiences a no demand for the product or service).
Mind of Marketing, "How your pricing and marketing strategy should be influenced by your customer's reference point" Nagle, Thomas and Holden, Reed.
The Strategy and Tactics of Pricing. Prentice Hall, 2002. Pages 84-104.
Focused Marketing Ltd.
Sales and Marketing Consultant