“Pricing is actually a pretty simple and straight forward thing. Customers will not pay literally a penny more than the true value of the product.” – Ron Johnson, CEO of JC Penney
Although Ron Johnson, former CEO of JC Penney, attempts to paint a simple picture of pricing strategy, it is clear it is not that simple to execute.
During Johnson’s 18-month tenure, sales plunged $4.3 billion while Johnson changed everything from the company’s marketing to the pricing, essentially changing the customer’s experience completely. Now with the former CEO taking back his seat, JC Penney is pleading for its customers to return. So is pricing really that simple?
The ability for a business to set the right price is an undervalued skill in today’s market. Companies quickly look for ways to cut costs and lower prices to increase volume, in hopes of increasing revenue. Rarely does a company revisit their pricing strategy or, dare I say, raise the price of their goods or services.
At its most basic definition, pricing strategy is the determination of a good or service’s best price based on various factors and objectives within and surrounding an organization. Pricing factors could include the demand curve, costs, marketing strategy and marketing mix decisions; pricing objectives could include profit maximization, product quality, survival or status quo. Understanding these inputs drives a business’s overall pricing strategy.
Developing an intentional pricing strategy versus a gut-feel approach is a crucial differentiator to an organization’s success and longevity. A price communicates more than just an exchange of goods for money; a price determines how much an organization will profit, a perceived value and customer benefits.
To begin your exploration of pricing strategy, the four pricing aspects below are a good start to better pricing awareness and can hopefully spark internal conversations on how to form and execute a deliberate pricing strategy.
1. Costs and Margins
The most fundamental aspect of pricing is to ensure, as an organization, you are at least covering your costs. When calculating the cost, include both the fixed and variable costs associated with your product or service to set the lowest price limit. To earn a profit, your price must completely cover the cost of your good or service. It is also prudent to assign a margin above your costs when determining price in order to gain a profit, also known as a markup. The profit margin has a direct relationship to your customer’s price sensitivity, but will strengthen viability in the market.
2. Customer Sensitivity
Understand the degree of sensitivity your customers have to price changes. Your organization should thoroughly understand the customer’s perspective relative to your product or service. The target market will have a perceived value of your offering thus it is vital you be in tune with it. If you have no experience with this, try gathering customer feedback using a survey to determine customer sensitivity to high and low price limits. If the survey is developed correctly, you’ll be able to understand the prices where customers think your product or service is not of value – either the high or low limits. Another option would be to experiment with your pricing in real time. In other words, raise your price in increments and see where you get a significant drop in sales. Ultimately, an organization will have to determine if the trade-off is worth it: lose a portion of customers to gain margin with higher prices.
For more information, check out this PDF, A Dashboard for Online Pricing, specifically the section on determining the optimal markup.
Determine in what ways your product or service adds incremental value that is not currently offered in the market. For example, if you perceive your product is of better quality, be comfortable setting the price higher than competitors. Inversely, if the intent is to produce a product or service cheaply and quality reflects that intent, set a lower price. A price can communicate benefits to a customer so the customer understands they pay more to receive a higher level of benefits. If the organization maintains a healthy mindset with pricing, customers will maintain a similar perception.
Consider the competition’s prices, but don’t let it dictate yours; the competition will always try to undercut you. Engaging in price wars is detrimental to your business as it forces you to reduce your prices to an uncomfortable level. Price wars influence a customer’s opinion of what the reasonable price should be thus the customer is less inclined to pay more for your good or service when the price war is over. Understand the difference between your product or service and the competitor’s, and then make the best decision on how to compete. To accomplish this, competitor data can be readily available and highly valuable. Companies such as Upstream Commerce, provide real-time pricing data that can facilitate understanding competitor’s products and prices. If the information is used effectively, pricing decisions will be more informed and influential in the market.
Developing and executing a pricing strategy is a science and has great implications for an organization both internally and for the customer. Price communicates a sense of pride. The best compliment customers can give you is choosing to pay your price because of their belief in the benefits and value of your product or service. To communicate this sentiment, an organization must be intentional in their pricing strategy.
Ron Johnson attempted to paint a simple picture of pricing, but as demonstrated by JC Penney’s woes, pricing extends beyond just numbers. Pricing strategy requires a deep understanding of your organization and customers to set the right price.
What about you? What kind of issues have you had with pricing in the past? Share your experience in the comments below.
If you are interested in learning more about pricing strategy and its impact to your organization, contact Credera to hear how we have helped our clients make pricing intentional.