Price is one of the main drivers of a company's profitability and survival over time. It is very common to hear "we don't sell because we are expensive" and in many of these cases, these arguments are not usually based on data. This generates a need to increase the value given for the same price, since lowering prices not only does not add value but decreases value, because nobody likes to buy "the cheapest", assuming that the cheapest is inferior. People seek to buy the best option, leading to a personal decision that does not always end up being the cheapest. This factor must be taken seriously by all entrepreneurs because no one wants to sell "the least profitable product".
Price and profitability
There are authors who claim that price is the only element that generates profit, but there are also broader views of the drivers of profitability that include volume and cost.
Volume is reflected in the company's market share and can be increased, but at the same time, costs are increased. The same is not true for price, which can go up or down without affecting costs. It should be borne in mind that if the volume is increased by lowering prices, the margin is reduced and the initial situation may worsen.
From a customer value point of view, the price is a reflection of what the customer is willing to pay. This is why it is of utmost importance to find the right price for each market. Where you are not known, the price you are willing to pay will be lower. The high price strategy is suitable for products with a high innovation component, and not for mature markets where there is a lot of competition and where profitability has to be taken care of.
Factors influencing the pricing decision
Users compare the price of a product with those of the competition, companies then need to use price to position their products in relation to the competition, at the same time taking into account the costs of the product, but not forgetting the value for the customer and the three basic objectives that can be achieved by changing prices:
Maximize profitability by lowering costs.
Change the perception of the product by varying prices and their respective value to the customer.
Modify demand by positioning the price according to that of the competition.
A more in-depth analysis of the factors to be taken into account when defining the pricing policy to be implemented should seek a balance between the different variables that intervene from the internal and external points of view.
Pricing strategies
Although economics bases its analysis on people's formal rationality, the use of some of its concepts, such as price elasticity and demand curves, provide valuable information to find the most profitable level for setting prices. In a market economy, if we raise the price of a product or service, the quantity demanded it will go down, and if we lower the price of that product or service, the quantity demanded will go up. The elasticity will tell us to what extent demand is affected by variations in price, there may be products or services for which the price increase produces a small variation in the quantity demanded, that is, consumers will buy regardless of price variations, this is called inelasticity. The inverse process is when the product or service is elastic, i.e. variations in the price modify the quantity demanded very much.
The model just explained is very useful to understand how delicate the task of defining the pricing strategy is, different criteria can be selected for its definition:
Non-fat prices: It consists of setting a high price for the launch sales of a new product, in order to maximize revenues, and obtain a higher contribution margin. As time goes by, and as there are other competitors for the product, the price is lowered.
Penetration prices: They set a low price to maximize the number of buyers and market share. With this strategy, low prices are launched to gain market penetration, which will then increase over time.
Prices per product line: This approach consists of setting prices by grouping them by product lines, taking into account cost differences per line, customers' evaluations (with different characteristics on a line-by-line basis) and competitors' prices.
By analyzing the three factors just mentioned, strategic decisions can be made on the price positions sought for different product lines.
Captive pricing: This refers to the setting of a price for products to be used in conjunction with the main product that has already been purchased.
Collective product prices: This consists of mixing several products to offer the whole for a lower price. This is a criterion widely used under the name of kits, where certain necessary and complementary elements are included for the installation of the main product.
Prices by customer type: It occurs when different customers pay different prices for the same product. This is a criterion widely used since the concept of volume discounts: the price varies according to the amount of purchase. In an effort to win a customer, a price reduction per customer can also be used to provide a differential and exclusive character that allows customer loyalty.
Prices per product version: With this type, different prices are set for different versions of the product, but not according to their costs.
Geographical prices: The more distant the area, the higher the price. Customers are generally charged for transport costs from the point of shipment of the product. This is also often used as a sales tool, where the seller absorbs part or all of the cost of shipping the products in order to have a competitive tool.
Seasonal prices: In these cases, prices are varied according to the seasonality of sales of the product. They are usually related to weather, holiday and school periods.
Psychological prices: This criterion considers different psychological aspects of prices, and not only economic ones because the price is used to say something about the product. An example is that a high price can be an important sign of higher quality.
Promotional prices: It consists of temporarily pricing products below their list price, and sometimes even below their cost, in order to increase sales in the short term. This approach cannot be taken as the sole method of pricing because, from a profitability point of view, it can be detrimental to the company's results.
Price change strategies: While the most commonly used means of changing prices is by changing their nominal price, there are other tools that allow changes to be made without affecting the monetary quantity.
However, there are other ways to change prices without changing their nominal value. While the most commonly used is the modification of the payment term, other means of changing prices without changing their nominal price are described below:
Additional products are free of charge.
Modification of the quantity of the product.
Free installation.
Additional guarantees.
Variation in product quality.
Delivery of incentives.
Consistency in pricing policy
The most important factor when defining a pricing strategy is that it should be coherent with the rest of the variables in the marketing mix. And one of the factors that give it coherence is that it should be sustained over time, and this maintenance should be understood from the point of view of perceived value, that is to say, from the customers' perception of price. On the other hand, coordination with the company's objectives and strategies gives pricing decisions the necessary coherence.
But this coherence does not only depend on the company's pricing decisions; it must also be analyzed in terms of what happens in the distribution channel. A widespread problem in industrial markets is the absence or lack of a reference price that is respected by the points of sale. There are few cases in which the same product is available at the same price throughout the country. These unfair commercial practices can be combated by defining and communicating suggested retail prices, and subsequent audits. But it is also appropriate to add that companies with different cost structures are competing in the market and that in many cases they have to sell the same products at the same prices, and the question arises: How can I compete if I am obliged to sell at the same price and my costs are higher? The answer lies in the product, more precisely the "augmented product" through intangibles that add value to transactions. These intangibles have no price but can be more valuable than the purchase cost that is offered to customers.
A basic task that the company can perform is to explain to its customers the origins of the costs of the products, as in the case of IKEA, which explains in its catalog the "magic formula", proposing four reasons that support it:
We keep things flat, we don't transport air >> Read: Logistics efficiency.
We abuse our products, we test them according to international standards. Believe us: they are strong >> Read: reduced losses due to returns, shrinkage and complaints due to consumer dissatisfaction.
We design for price first. To make good quality furniture at a low price our designers have to think differently >> Read: this is our big secret, we are creative and down to earth.
You make your own moves and we'll spend the money to do it >> Read: smart cost management. Pass on to the customer the efforts he does not want to pay for.
This consistency in pricing must be derived from a well-structured pricing strategy. If this integrity is not perceived, customers are likely to start looking for information from competitors.
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