By: Jenifer Horvath, AWE Business Advisor
Determining the price point for your products or services can seem challenging. You get caught between needing to cover your expenses, make a profit, while also trying to make the price appealing to sell in high volumes.
At AWE's Learning Day, Sparking Solutions event, we held a series of business challenges. Pricing, not surprisingly, came up as a common problem and attendees provided solutions and insights based on their own experience. Here are two that we examined.
Challenge: How do I set prices in an industry that has big variances in price points?
In many industries, such as consulting, automobile, and cosmetics, there is a considerable variation in prices between companies. For example, when you go to purchase a car, you could get a used vehicle for $3,000 or step into a dealership and buy a brand new vehicle for upwards of $150,000. As an entrepreneur, this poses the challenge of how to set a good price for your product when there seems to be little consistency between vendors.
Step One: Examine Value-Based Pricing
Value-based price is a pricing strategy which sets prices primarily, but not exclusively, according to the perceived or estimated value of a product or service to the customer rather than according to the cost of the product or historical prices. - Wikipedia
The first step in value-based pricing is to look at your ideal customer. Knowing your customer deeply means understanding their demographics, psychographics, situation, and needs. For example, we mistakenly think that people who buy luxury items are high-income earners, but that’s not necessarily true. A lower income earner will buy for aspirational reasons, or because the product/ service fills a deep need.
Apple, for example, sells premium products to individuals with a wide array of demographics. Buying Apple products is all about the customer feeling like they’re a better person and fulfills the need to fit in, or to reflect their values through the Apple brand. On the other hand, a low price, high volume shampoo may also have a wide range of buyers due to convenience, habits, or a person’s mindset on money. Put yourself in your customer shoes and see the whole experience as they would. Get curious and ask your customers lots of questions.
The next step in value-based pricing is to look at what differentiates you from other companies offering a similar product/service. By looking at what sets you apart, you can also determine what you can reasonably charge. What added value do you bring? Why would a customer buy yours, over another?
Step Two: Run Cost-Based Pricing
Another critical step is to look at all your overhead costs and expenses and how much of a profit margin you are willing to accept. Ensure that you don’t sell your product for less than what it costs to make. When building cost-based pricing, make sure to include all your time and administration work. Think of all the back-end work you have to do for your bookkeeping, marketing, sales, packaging and other tasks and make sure to add that into the price. Do both a high end and low-end price to get a rough estimate of where you can price your offering.
A good rule of thumb to follow is to price your product higher initially and then lower it in the future if needed. It’s much harder to convince people to buy for a higher price once they’ve been paying for the lower one.
Finally, test and learn. Sometimes we don’t know what we don’t know until you try it. Research and collect data regularly to determine what those in your industry are charging and how your sales are doing from one period to the next.
Challenge: How do I set pricing when my competitors are cutting their rates? How do I survive when I have a building, staff and other operating costs?
When you are trying to set your prices in an industry where you have multiple competitors who are cutting their rates, it’s crucial that you take a step back and analyze the situation.
What is causing them to drop their rates? Is there increased competition, is the customer demanding it, or is it merely a race to the bottom out of fear? Is it sustainable over the long term? What’s happening in the industry?
Then, look at the value you can provide your customers. Get clear on your “why” and ensure your brand articulates who you are and the value you offer. Is it consistent, reliable, and trustworthy? Do you have a compelling brand story?
Before cutting your price, look at ways to offer more value instead. For example, in the highly-competitive coffee world, Starbucks differentiates itself with personalization. They offer 100’s of ways to personalize your drink. Their app makes it more personalized in your hand by tracking orders, saving favourites and earning the “gold card’. They use your first name and make an effort to connect with you individually.
As Tim Hortons and McDonald's fight for share-of-coffee (amongst other things), Starbucks continues to offer value and a brand that creates loyal customers who will continue to pay $5+ for a beverage. Loyal customers are less likely to be influenced by price because they get value beyond the practical use of the product/ service.
What can you do to add value to create loyal customers?
If you feel you need to lower prices to attract people, make sure to look at your costs and figure out how to reduce them, to maintain your profit margin. For example, keeping less inventory on hand or cutting back on material costs.
Businesses can use incentives to temporarily reduce their prices and drive purchases. Incentives could be a discount, coupon for a future purchase, or a free trial. However, remember, by offering ongoing coupons or discounts, your training your customers to expect this and to wait until the next offer. Do this sparingly, unless it’s your primary marketing strategy like how Old Navy uses sales continuously to drive sales.
In some businesses, you may be able to introduce tiered pricing. This approach incentivizes customers to buy more and get a lower price per unit. Package pricing, where you combine multiple products/ services, is another way to differentiate your offer. Also, if possible, subscription or membership models are an excellent way to increase recurring revenue and lower your sales costs because you have higher customer retention.
When you see competitors changing their rates, don’t have a knee-jerk reaction and change yours. Take a look at the situation, industry, and your value. See if you can offer something else or new, or look at changing your pricing models. Find ways to reduce costs before you lower your prices or offer discounts. Remember, you need to run a profitable business, and if it isn’t, then you can’t be operational for long.