Right price: A path to running a profitable business
We have seen considerable changes in customer behaviour as challenges such as the pandemic, the unrest in July, and rolling blackouts have eroded business and consumer confidence and income. Sage research found that 51% of South African businesses agreed customer purchase behaviour has changed following COVID-19.
While 70% said customer demand for their product and services has increased, 52% reported their business costs have increased. Supply chain disruptions, exchange rate volatility, and a robust and coherent approach to setting price points for your products and services is key to being sustainable and remaining profitable.
It’s a delicate balance between offering an attractive customer proposition and optimising the margins you make on the products and services you provide. There is no universal formula, given that customer price sensitivity and the volatility of input costs range across different industries and markets.
Companies should consider some principles that can help them set the right price.
Find the right pricing strategy and architecture for your business
There are several methodologies you can use to set the prices for the products and services you sell. Many businesses take the easy way out by simply adding a markup to their costs and changing the price each time their expenses increase. This isn’t always the optimal approach as it means you are continuously reacting to external events that highlight your costs to the customer rather than your value.
Just a few of the other common approaches include:
- Competitive pricing – Tracking what your competitors charge in as near to real-time as possible and adjusting pricing in response. Most companies in price-sensitive sectors where comparison shopping is easy (like e-commerce retail) may need an element of this in their overall strategy. Still, again, it shouldn’t be the primary determinant of your price.
- Loss leader pricing – Using some aggressively priced products to attract customers and entice them to buy higher-margin products.
- Value-based pricing – Setting prices primarily based on the customer’s perceived value of a product or service.
- Premium pricing – Selling premium products and services to customers that want quality and exclusive goods.
- Price skimming – inflating the price of goods or services at the time of launch and then lowering them as market penetration increases. This is great when you have a product that early adopters will buy at a premium.
- Penetration pricing – Offering new products at lower prices to gain market share, then ramping up costs as adoption rises.
As these examples show, there is more to price-setting than adding a profit margin. It can be a strategic tool to drive customer growth and retention and increase profits over time.
Understand customer personas
Understanding your customers and their wants and needs is key to setting the correct price levels. It can be helpful to segment them or create personas. Think about each potential customer’s motivations and requirements. For example, a clothing store might want to adopt different product and pricing strategies to address young parents trying to make ends meet compared to those targeted at high-earning, childless professionals. This will help tier your pricing and product offering in a coherent way for different demographics.
Create a perception of value
In the first point, I alluded to value-based pricing. Even if you do not explicitly choose this as your pricing strategy, the value should be an essential driver in your approach to pricing. The most successful businesses spend as much time nurturing the perception of high importance among their customers as they set the price. Ideally, you want the customer to value your product or service enough that they won’t switch to a new provider to save 1% or 2%.
There are many ways in which you can increase the perceived value of your offering:
- Rebrand it or change the packaging, especially if the existing look is a little old-fashioned.
- Convey scarcity or urgency. Indicate that the item may go out of stock or that there is only limited time to access it at its present point.
- Put the price in context. For example, R600 for a month of gym fees may look expensive, but not when contextualised as two meals out for two.
- Offer a proof point. Talk about how much time, money and stress someone can save by using your tax consulting services rather than simply presenting a price.
- Frame it next to a more expensive alternative. A common restaurant trick is to put the price of the most expensive bottle of wine next to the moderately costly bottle the owner hopes you will buy.
Bundling is a powerful strategy in many industries
Bundling has become a science in various industries, for example, the fast-food industry and their Happy Meals or Streetwise deals. Putting together an offering helps customers choose faster and create a perception they are getting real value for money. To get it right, you need to offer complementary products people would usually want to buy together.
For example, people will usually want a coffee with a croissant or a coke with a burger and chips, rather than the other way around. Decoy pricing can be helpful here. A cold drink from a machine, for example, is a cheap, high margin product for a restaurant.
Continuously measure and report
Pricing is dynamic, which means the most successful businesses continuously assess whether they are meeting their strategic objectives. Some of the possible questions to ask include:
- How does it affect my business if my online and offline pricing is different?
- Do we make more money when we sell slightly lower volumes at higher prices?
- Which bundles are selling well, and how profitable are they?
- Are we giving away things for which we could be charging?
- What is our customers’ tolerance for higher pricing?
Your accounting system can help you generate budgets and forecasts that will give you the insights you need to make the right decisions. Remember, even small changes can make a huge difference. A company selling sauces and chips could, for instance, become more profitable simply by charging for the sauces rather than giving them away.
Path to profitability
Treating pricing as a strategic priority can set your business up for long-term success. Getting it wrong means you’ll constantly struggle to regain lost market share or income because you priced an offering too high or too low. Mastering the science of setting the right price points for your products and services will help you grow your business, maintain a healthy cash flow, and drive profitability.
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