Pricing methods (How to price your products and services correctly?)

Rafat Abushaban

- Sales #  O 3K views   اقرأ بالعربية

Summary:Pricing mechanisms outline how buyers and sellers are matched through price, which can either be fixed or dynamic.

Since a startup is built on the notion of selling products and/or services to customers, the 'price' these customers pay for these services forms an integral determinant affecting the marketability, cost-effectiveness, profitability, and sustainability of the businesses.

Understanding Pricing: Cost-plus Pricing

For pricing to be effective, it needs to cover costs of producing a product or service in addition to a margin to reach the break even point. Cost-plus pricing is a strategy used to determine prices by calculating the costs and then adding a margin for profit.

For example let's say take Sanabel, a bakery and they sell Pizza and other products. They want to calculate the price for their standard-size pizza. Sanabel's management has calculated the costs related to baking and preparing their Pizzas and estimated their markup as follows:

Direct Costs (ingredients) per unit$2.5
Indirect Costs (oven, heating, wages, rent) per unit$2.5
Markup (Acceptable rate of return)%10

This means that the markup price = markup percentage x total cost

Markup price0.10 x 5 = 0.5

As thus, the price should be = total cost + markup price

Selling price5 + 0.5 = $5.5

Although Cost-plus pricing is widely used among traditional stores and brick-and-mortars, it disregards market positioning and other elements. For startups and fast-moving businesses need to view other more creative alternatives to adopt as a tactic for pricing.

Below we delve into some of the common (and uncommon) methods used by sellers to determine prices of goods and services.

Discounting Pricing Tactic

Discounting tactic Ever walked across a store and saw the sign "SALE" that drew you in? this is called the Discounting Tactic as the business offers reduced prices for a certain period of time or certain type of audience.

Common types of discounts include:

  • Seasonal discounts for out-of-season products.
  • Payment discounts for customers paying upfront as compared to customers buying on credit or installments.
  • Age-bound discounts for seniors or children.
  • Education discounts for school and college students.
  • Large quantity discount for customers who buy multiple instances of a product.
  • Service discount for customers who buy a part of the full offering (pay for shipping or do the installment themselves).

While discounting is considered an attractive concept to lure customers in for the low prices, it should be handled with care. Weak-planned and long-term discounts tend to make the businesses lose capital.

Value-based pricing

Pricing based on value is a practice adopted by mane high-end manufacturers and sellers for goods and services that appeal to customers in a certain way, especially in Niche Markets. Here, the pricing value is based on the perceived value by the customer of the product or service.

In order to be able to price based on value, a business must understand the value they are bringing to the customer and the perceived value by this customer. This includes a set of activities:

  • A deep understanding of the Business Problem is essential, as well as understanding the Market Segmentation that the business is operating in.
  • Undertaking Market Research to identify, understand and analyze the targeted customer and their behavior.
  • Researching Competition and what products and services are already being offered in the same market niche, and verifying the Competitive Advantage
  • Understanding the willingness and ability of customer to pay, this means the maximum amount a customer will be willing to pay in exchange for getting the offer
  • Making sure that the price covers total costs for production in addition to a markup (such as the Cost-plus pricing strategy above).

Competitive Pricing

Competitive pricing relies heavily on competition's price to determine own prices. Here, a business evaluates the market and evaluates the prices of the competition, and then sets a price lower than what's available in the market. This strategy is a good start for small businesses, but not always advisable for adoption in more mature scenarios as it directly relies on external factors to calculate prices, as well as lacking room for growth and adaption.

A special subset of this approach often used by mass-producers is Economy Pricing where setting the lower-than-competition prices can be covered by the economies of scale.

Geographic Pricing

Price tag Geographic pricing is targeting different geographical locations with different prices. This tactic focuses mostly on shipping and taxation costs and the relevant effect of changing the prices across different locations.

Take for example an online seller that you want to buy a shirt from. If you are in the same country as the seller, you will get it for $10. If you live outside this country, you will get it for $15. Such a scenario is a clear indicators that shipping/taxes for the products outside the country of the seller cost $5.

Price Skimming & Penetration

Since pricing directly affects the buying decision, it is often used in a way to lure customers in. Such techniques are called Price Skimming and Penetration.

Price Skimming is setting a high price for a given product or service (relevant to the Value-based pricing tactic). However, here the main difference is that the price is lowered according to how the market reacts.

On the opposite side, Price Penetration is used as a tactic to facilitate Market Penetration by introducing a given product or service at a low price, but raising it later according to how the market reacts.

Optional Pricing

An Optional Pricing tactic means having a base product with options to be added. Here, the customer is given the opportunity to select if they need certain optional addons or services to be associated with the base product.

For example, when buying a Pizza from Sanabel for $5.5, one could ask for extra topping for an additional $1.

Dynamic Pricing

Similar to the constantly changing prices of the stock market, the Dynamic Pricing tactic states that it is possible to change prices for certain goods and services depending on the rise and fall in demand. A good example on this is flight ticket prices that change depending on the season and time of year.

Rafat Abushaban

Founder of Riable and consultant to several international organizations in entrepreneurship education and researcher in innovation systems and seed funding methods with 10+ years of practical experience in the MENA region, Europe, US and S.Korea
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