Pricing is an art and a science, easily measured yet often irrational. It isn’t something you can afford to get wrong, not only does it drive your financial performance; it also makes a statement about the value of what you’re selling.
There’s not just one singular pricing strategy either. I’d argue that there are three ways of looking at it, each of them equally valid. Let’s use a popular example, Beer.
- It’s a hot day and you’re at a supermarket bottle shop. You go to buy a Corona. How much will you pay? $2 or $3? Probably. Maybe if the costs of making beer went up you’d pay $3.50, but for now it’s about $3
- Now you’re out for after-work drinks, choosing between three neighbouring bars on a Friday evening.
Bar #1 advertises “$7 Coronas”
Bar #2 advertises “Coronas $7.50”.
How much is Bar #3 likely to charge?
Probably somewhere between $6.50 and $8. If they tried to go much higher, they’d lose out to the competition.
- The next day you’re at the MCG along with 100,000 other fans. You line up to get a beer. Oh look, they now sell Coronas! How much do you expect to pay? An arm and a leg? You have no alternative. It’s either pay up, or go without, so you brace yourself to pay far too much, but it’s still worth it.
Right there we have the three pricing strategies applied to the same product.
- Supermarkets usually take the raw cost of a product, slap on a margin, and that’s the price. This is the “Costs Plus” approach.
- Bars on Main St set prices with reference to their nearby competitors, to lure in customers. If the costs of production increased, the price might not, as being more expensive than the competition isn’t going to win much business. This is the “Market Based” approach.
- When you’re at a music festival, a sporting event or stuck at an airport, the rules change. You have no alternatives, no competitors to choose between. Companies know this, and so use the “Value Based” approach to pricing. If a cold beer is worth a lot, you’ll pay a lot, irrespective of how little it cost them to buy the beer in the first place.
Your job is to know what each of these numbers looks like for your industry. The price you set needs to take all three into account. To ignore one of them would be a disaster. If you charge less than you paid for it, you lose money (occasionally valid if it leads to further sales). If you don’t watch what the market is charging, you risk losing customers (like how petrol price cartels operate). If you charge more than what it’s worth to your customer, you will have zero sales (even if you’re using low margins or are cheaper than competitors), customers would rather choose the “do nothing” option.
What do they look like for your business? Are you guessing or are you testing? Running a few small experiments is so easy, and could significantly increase your viability.
How much does your customer know about the decision they’re making?
When consumers enter a world they know little about, and don’t understand the foreign terminology and jargon, price becomes the de-facto indicator of quality.
Is your customer likely to scan the options and pick the cheapest, the middle, or the premium option?
Keep these questions in mind each time you buy something new. What does the “right price” look like for a product/service you’ve never encountered before? And what are your customers’ actions telling you about your pricing model?