We’re certain that from a startup introducing its first product or device to a large corporation launching a new line of merchandise, the question of what’s the most profitable and attractive price (what’s typically called a “price point”) is an essential part of the picture.
Effective product pricing is like getting that sail set at the optimum angle to catch the wind and let your business sail towards is goals, in the vast ocean of commerce. It’s not just about covering costs or turning a profit; your pricing decisions can influence how your products are perceived in the marketplace, drive demand, and even create your identity as a brand.
The Pricing Sweet Spot: The Goldilocks Metaphor
In Goldilocks and the Three Bears, Goldilocks experiments with three bowls of porridge. One of them is too hot and cold but the third is just right. This story provides a great metaphor for one of the most important parts of business – pricing. The trick is arriving at a price that is not so cheap as to discourage potential customers, or so cheap as to make the offering unprofitable, but ‘just right’.
Consider Apple’s pricing strategy, particularly for its flagship iPhone product. Of course, their products also carried a higher price tag than most of their competitors won in smartphone land. But now, Apple has found its ‘Goldilocks’ price — not too high to be out of reach of its target market’s ability or willingness to pay, but high enough to preserve a premium brand image and notch up heavy profits.
Apple’s pricing behavior also has the benefit of helping the company establish itself as a high-end brand, encouraging people to shell out for products they see as being of higher quality and sophistication. It is the very best porridge, made after months of market research and consumer profiling, from a unique bowl called the ‘Apple’.
Understanding your product, knowing your customers, and being able to gauge what someone would pay (or better yet, several someones), are key to finding that ‘just right’ cost.
Understanding Costs: The Foundations of Pricing
The path to the ideal price for your products starts at home – in your own business model. Like the blueprint for a building, your pricing model is rooted in your business’s cost structure. These are the ones that make up your cost of manufacturing, marketing, and delivery of your product into the hands of the customer. For example, fixed and variable costs.
Fixed costs, like the foundation of a house, are the costs that are incurred even if you don’t sell anything. Such expenses may include rent for office space, salaries of full-time employees, and insurance costs. Variable costs in contrast, fluctuate depending on the level of output. They are like the bricks and mortar in your building that may grow or shrink as you add more or less of either. Those costs consist of raw material costs, production linked energy costs, and sales commissions.
By knowing these costs, companies can calculate the lowest price at which they can sell the product to cover costs – the break-even point price. This information is critical, because any sales below that price will result in losses.
Consider Tesla, for example. Electric car makers have high fixed costs like building and maintaining their Gigafactories. They are also exposed to variable costs like the cost of lithium-ion batteries, which power their vehicles. These are the things the pricing of Tesla depends on, heavily. Tesla does have a lot of loyal customers who love the company’s forward-thinking tech and green cred even though its cars are super expensive.
But cost-based pricing just scratches the surface, however. The ” perfect ” price point takes other factors such as demand in the market, competition, and perceived value into account. In the sections ahead, we will address these variables in order to obtain a comprehensive understanding of pricing tactics.
The Demand Curve: Riding the Waves
Pricing an item isn’t a solitary pursuit; it’s a waltz with supply and demand. To appreciate how market demand works with pricing, imagine a surfer in the ocean, watching the rhythms of the waves to catch the right wave. Sure, companies have to be effective market researchers in order to find and grab a piece of the ‘wave’.
When the price goes up, demand generally drops, and vice versa. This is a perfect example of the basic law of demand that posits (all other things being equal) that customer demand for a good or service will decline with an increase in its price.
One important concept here is “price elasticity,” which measures how much demand changes as prices do. The product is called “elastic” if a small change in price leads to a large quantity demand. If demand doesn’t shift much as price does, demand is considered “inelastic.”
There is an interesting example of this with luxury brands such as Rolex. Regarding Rolex watches, the demand is mostly inelastic. While prices are lofty, interest in these high-end watches is seemingly unwavering. This could be attributed to the fact that Rolex has created a strong brand identity and value that makes people less price sensitive.
When it comes time to price, firms should look at how elastic their products are, a judgment that more often than not is a byproduct of strong market research. Whether you’re surfing on a “steep” (elastic) wave or a “gentle” (inelastic) one will guide the way you set and adjust prices, much the same way a surfer’s approach to a wave is dictated by its shape and speed.
Competition-Based Pricing: The Race
When you’re trying to price your products, it can sometimes feel like you’re running in a race, but your competitors are moving the target as you run towards it. You can try to outpace them, or keep up, while also making sure that you keep breathing and either preserve your specific running style (brand value) or not lose sight of it somewhere up the road. This is the crux of competition-based pricing – decide your price point based on what the other guy is doing.
Competition-oriented pricing is especially common in products that are undifferentiated, the alternatives are similar, and the price becomes an important tool for differentiation. But, competition still has a strong say in such markets where choice is abundant.
There are several ways to do this: you could price your product under competition pricing, which would attract value oriented customers, or match your competitor’s pricing inorder to keep market share; you could also price your product over your competition’s and emphasize how that price reflected superior quality.
Think about the variable pricing strategies employed by the airlines. The price of a seat on a flight can fluctuate multiple times per day, depending on a variety of factors, including seat availability, time of purchase, and, crucially, prices posted by rival airlines. It’s a strategic race where the runners are constantly changing pace.
But the race is also about something more than speed; endurance and strategy factor in as well. And that’s where value-based pricing comes in. It lets businesses differentiate pricing based on the unique value they offer to customers, rather than simply follow what competitors are doing.
Value-Based Pricing: The Art Gallery Metaphor
If you’ve ever walked around an art gallery, you may have noticed that the prices of works don’t necessarily reflect the value of the paint, canvas and the artist’s time. Rather, they represent how valuable the art is believed to be—including how well known the creator is, how it makes the viewer feel, and how culturally relevant it is. It is akin to value-based pricing, a strategy in which prices are determined by a customer’s valuation of a good or service, rather than the cost of producing that good or service, or the prevailing rate in the market.
From 2016, the cost-plus focuses on meeting the client’s requirements, rather than being price-focused by the supply chain. It wants to find a price where when your customers pay, they think they are receiving that value.
Take the pricing model of Starbucks, for instance. Well, it may not all be that different from any other coffee shop but Starbucks is not priced the same way as any other coffee shop. This is why it happens; the perceived value of what being in Starbucks gives you – warm, well-lit stores, well-managed product, a status of being a Starbucks customer, and a personalised service to some extent – your name on a cup.
With value-based pricing, you are putting yourself in a unique space in the market, in the same way that an artist finds a niche in a gallery. “Knowing what a client needs, how to add value and price that need is critical. The next chapter describes how companies mess with your mind when pricing their products. In the same way that an artist paints with details, these subtle strategies can help to greatly impact a customer’s perception and actions.
Psychological Pricing: Playing Mind Games
Psychological pricing is the goalkeeper’s bluff in the soccer match of commerce. Just as a goalkeeper might lean slightly to one side to trick the penalty taker into aiming the other way, businesses use psychology to nudge customers toward making a purchase.
One form of psychological pricing is known as ‘charm pricing’. For example, pricing a product with a price that is. 99 or. 97 instead of rounding to the next whole number. The thinking is that $4.99 looks a lot cheaper than $5.00 to consumers, even though the difference is only a penny.
For example, Walmart is famous for its “Everyday Low Prices.” It’s not unusual to see prices that all end in. 97, which makes customers feel as if they’re getting a deal and motivates them to buy. These psychological pricing tricks can have a dramatic effect on consumer behavior, proving that it truly is an art form as much as a science.
Dynamic Pricing: The Weather Metaphor
Just as weather patterns vary over the course of the day, dynamic pricing is a tactic in which prices fluctuate depending on market conditions. The way you would carry an umbrella on a day when rain is in the forecast, or wear a lighter coat in the morning when the weather is expected to be nice in the afternoon, businesses adjust prices to reflect fluctuations in demand, supply and other market conditions.
This strategy allows businesses to maximize profitability during high-demand periods and stimulate sales during slower times. However, dynamic pricing can be a double-edged sword. While it may increase profits, it can also lead to customer satisfaction if managed carefully.
One example of dynamic pricing is Uber’s surge pricing. When there’s a huge demand for rides — for example, at rush hour, or in inclement weather — prices rise. That strategy serves to level out demand and supply, though there have also been controversial spikes in prices. It’s a business analogy to a sudden rainstorm, which will be good for the ecosystem in the end but may leave some customers feeling wetter than they’d like.
Pricing for Different Stages of the Product Life Cycle: The Seasons Metaphor
Conclusion
Pricing your product is a tricky devil of a dance in the world of commerce. It’s about being aware of your expenses, estimating demand and competitive pressure, evaluating the perception of value, borrowing from the lessons of psychology and maintaining a pulse on the market. Getting the price right is like navigating the ocean while running a marathon, curating a fine art gallery during a game of chess and making a weather forecast, all at the same time.
