Pricing for Profitability

PRICING FOR PROFITABILITY:

PRICING IS A FORMIDABLE WEAPON IN YOUR MARKETPLACE WARS WITH COMPETITORS

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Is your pricing policy helping or hindering your company? If there is one lesson to be learned about pricing policy and price management, it is this: there is a direct link between prices and business performance. In pricing for profitability, you ignore this link at your peril.

Chiron! the business doctor’s™ pricing philosophy is this: if your prices are going up, that’s why customers should buy now! If your prices are going down, that’s why customers should buy! Either way your prices go, customers should buy!

Warning: There is a considerable amount of information here relating to pricing policy and the mechanics of setting prices. I understand how important this information is to you when making up your mind as to who can best help you with the operational management of your business. Consequently, as the guide covers a lot of ground, expect a long read.

Pricing: a sensitive, contentious and controversial issue

Hi there and welcome. Through this webpage, I will discuss with you one of the most sensitive, contentious and controversial issues of being in business: the pricing of your products and services. It doesn’t matter whether you are a multinational corporation or a small or mid-size business owner, you cannot escape the fact that in setting your prices, you must sell your products or services for enough profit to remain in business for the long haul. This task is not easy. There are many pitfalls that can damage your company if your pricing for profitability decisions are wrong in some way.

There is a direct relationship between your profits and your prices

Nothing influences your bottom line as much as the prices for which you sell your products and services. In turn, nothing influences your prices as much as your profit margin on sales. When setting your prices therefore, the reality is that the prices at which you do sell will always have a profound effect on your company’s profitability and long-term viability. As a sidebar effect, your prices will also strongly influence the public perception of your company and its’ products and services. Whether true or not, customers tend to accept prices as indicators of quality and value.

Pricing profoundly affects your company’s future. There is no doubt therefore that any persons charged with the complex task of pricing for profitability must have nerve, guts, audacity and daring. After all, their decisions will profoundly affect the future of the company. More particularly, their decisions will also have a profound effect on shareholder confidence. Shareholder confidence is a key factor in business success.

Price setting is dynamic, complex and sensitive

Pricing is sensitive & complex. As Chiron! the business doctor.™, I fully understand the sensitivity involved in setting prices. As Chiron! the business doctor.™, I also understand that the process of setting prices is complex, and is always bound up with your profitability objectives, which in turn are determined by the marketplace position that you desire for your company. Consequently, many significant and important factors can influence the prices at which you sell your products and services from time to time. The trick is to make sure that you consider all these factors in the price-decision procedure.

Pricing is dynamic. Pricing, as a functional activity, has the reputation of being the most dynamic of all the variables in a company’s marketing mix. That reputation simply reflects the fact that pricing is the variable that is most subject to external forces. These forces include, but are not limited to, competitive pressures, economic developments and demand fluctuations. From another perspective however (one that goes beyond the recognition of pricing as simply a dynamic element in the marketing mix), pricing is the unique variable in the marketing mix.

Pricing is unique

Pricing is unique. Why do I say that pricing is the unique variable in the marketing mix? I say pricing is the unique variable for two compelling reasons. Viewed in comparison with other marketing mix variables, pricing:

  • is the only variable that does not involve any expenditure, and
  • is the only variable that directly increases revenue.

Pricing is flexible. I am sure that statement is no surprise to you. Consequently, the uniqueness of pricing provides flexibility to companies to change their prices more quickly and more frequently than is possible with other marketing mix variables.

With the exception of price, all marketing mix variables involve a cost to your company

Cost/revenue implications. As you know from your own business experience, marketing mix variables include, inter alia, advertising, sales promotions, packaging, product design, product development and distribution. All these variables involve a financial cost to a greater or lesser degree. Pricing changes, on the other hand, do not incur any expenditure. In fact, the opposite is true. Rather than increasing costs, price is the only marketing mix variable that directly increases revenue.

Additional factors. This raises a fascinating and rare convergence of factors that do not attract the degree of attention they deserve. I am sure that you will pay attention to this convergence; otherwise you probably would not have delved this far down into this webpage. Although this material is quite heavy going, I am pleased that you are still with me, because this is all relevant to how you should approach pricing policy and price setting.

Pricing: the heart of every business exchange relationship

Importance of price. When you align the uniqueness of prices with its revenue creating ability, you are just one small step from reaching the inevitable conclusion that price is both the most fundamental and the most vital variable in the marketing mix. That is because pricing lies at the very heart of every business exchange relationship. No exchange ever takes place between a seller and a buyer without a pre-agreed price. Whether that price is declared in cash or in kind, it is still a price; and that price will be a key determinant as to whether or not customers will purchase the product or service, how much they will purchase, and whether they will be satisfied with their purchase.

Price: the customer perspective

Price: the positive; the negative. Customers view price from two contrary angles; one positive and one negative. From a negative perspective, price represents an outlay of economic resources, usually money. This can be an obstruction to purchase if the customer thinks the price is too high and alternative cheaper ways to resolve the customer’s needs are available.

Price: indicator of quality. From the contrary perspective, price has a positive role in that it can suggest the level of quality of the products and services: the higher the price, the higher the quality. Whether that is true or not, it raises the point that in setting prices, you must give a lot of thought to the relationship between price and quality.

Customers often use price as a signal of product quality

Customers use price. Customers consistently pay higher prices to buy one brand rather than another on the assumption that the higher-priced brand, on the balance of probabilities, is of a higher quality. In this situation, customers are using price as a signal of product quality. Of course, if customers have the opportunity to judge product quality (e.g. by company reputation, by product testing, by feel or touch, or by taste and smell), then they have no need to rely on price to appraise quality. But in most purchase circumstances, customers will not have access to these methods of appraising quality. These customers have no way of objectively knowing in any technical sense how good a product is, even though they may be able to inspect the product at point of purchase.

This is a reason that price becomes such a significant quality signal in the customer’s mind. Marketing experts suggest that price becomes a significant signal of product quality when:

  • purchase risk is high and customers want to reduce the odds of making an imprudent purchase decision,
  • customers cannot appraise product quality because they do not have the time or the desire to determine product quality and consequently they use price as a readily available and easily understood indicator of quality,
  • customers lack the expertise, ability or opportunity to personally appraise product quality, and
  • customers are not closely involved in the purchase event and rely on price as the quality indicator, rather than take the personal effort to appraise the product’s quality.

Pricing for Profitability: the price-setter perspective

Price can be constraining. Price, from the price-setter’s perspective, is a complex subject that we can best discuss directly having regard to your company’s situation. The subject is actually just too big to get a handle on it in one webpage. What I can say to you is this. The existing circumstances surrounding your company at the precise time that you need to determine your pricing policy will inevitably set the boundaries for your pricing policy. These circumstances will limit your ability to set your prices freely. At one extreme, you will set your prices to generate a sufficient cash flow to survive a short-term challenge from competitors. At the other extreme, you will set your prices to maximise long-term profits.

Options and tactics. In between those extremes are alternative objectives that provide a range of strategic options and tactics that will decide your future course of action, a term that is shorthand for the future of your company. These strategic options and tactics will limit your ability to freely set your prices. They will, inter alia, include such topics as the achievement of sales and market share goals, the realisation of a defined return on shareholders’ investments, the projection of a desired positive image through a price signal or just simply the maintenance of your status quo.

Pricing is complex. The complexity surrounding the development and application of a pricing policy therefore is such that to do it justice, we need to discuss it directly on a one-to-one basis. I invite you to call me confidentially on (+61) 0404 631 230 at any time of your convenience to discuss how I can help you deal with this sensitive and important subject.

Price Wars

Some pricing factors are beyond control. I mentioned earlier that many significant factors influence the prices at which you sell your products and services from time to time. Many of these factors are beyond your control, and are often the consequence of actions by others, in particular, your suppliers and your competitors. There are two factors involved here.

Price wars. As explained above, the first is that you need to ensure that you have an orderly process to set your prices within the context of your commercial objectives. The second concerns how you react to external events that impinge on your price setting procedure. For example, you need to know how to deal with a price war and you need to know how to limit the damage a price war can do to your company. You also need to know how to start and successfully prosecute a price war, if external circumstances combine to recommend such a course of action.

Don’t ignore the relationship between pricing policy and discount policy

Pricing policy and discount policy. Another important aspect of price setting concerns the relationship between pricing policy and discount policy. If the relationship between pricing policy and discount policy is not controlled, discounts can seriously damage your business. The degree of discretion that you permit your sales force to exercise over discounts will, speaking generally, have a detrimental effect. Some shrewd accountants define discounts as ‘buying back the business after you’ve sold it’. I’m sure you get the message here. In the practical realities of business life, you will also need to know how to use your pricing policy to deal with heavy discounting by your competitors.

Morality

What’s this about morality? You may wonder what I am leading to under a heading of ‘morality’. Well, my purpose is this: there is no denying that a sensitive aspect of price setting concerns your personal attitude to issues of morality and how those personal attitudes impinge on or otherwise affect your company’s performance. Can a profit level be too high? Should you price for customers on the aged pension? The effect of morality on price setting and business performance is one that is difficult to quantify, but rests almost entirely in the minds of those setting prices. Only you know what is morally right for yourself, and only you can determine how much you will permit this to influence your pricing decisions.

There is a direct link between prices and business performance: ignore it at your peril

Price behaviour. In traditionally organised markets, prices obey distinct laws of behaviour. Governments, companies or individual traders can distort a market by complying with particular economic theories. Monetary policy comes to mind in the case of governments. In the case of companies, marketing theories such as penetration pricing or accountancy practices such as standard costing come to mind. However, if the chosen theory does not flow in harmony with the natural process of the market, then the effects on the company concerned are always uncomfortable, generally unpleasant and on occasions, can be fatal.

From the corporate point of view, pricing policy is at the heart of company philosophy: the average selling price of your company’s products, when multiplied by the amount of products you sell and reduced by your costs of production, creates your company revenue. The result of that equation is your company’s future. The future could be bright with expansion possibilities, or it could be dark through bankruptcy, liquidation or forced sale. The future is therefore dependent upon the equation: Prices times Volume of Sales minus Costs of all kinds.

The single most important factor leading to business success

The most important business success factor. Extensive research undertaken some time ago in the United Kingdom sought to find out what was the single most important factor leading to business success. Ninety percent (90%) of the 240 larger companies that participated in the project over a three and a half year period overwhelming reported that the single most important factor leading to business success was the profit margin on sales. Although this research was conducted some years ago, there is no evidence available to suggest that the research results are not still valid.

The profit margin on sales. If the profit margin on sales is the single most important factor leading to business success, then clearly, pricing is at the very heart of business success. Consequently, you cannot set your prices without first determining your optimum profit margin on sales for each of your products or services.

Last Word

Chiron! the business doctor.™: your team’s 12th man. Can you see how your company can benefit from my help in establishing procedures that can lead to an effective pricing policy? Given the importance and high profile of pricing policy within the management of your company, I know that you always wish to be on top of the pricing policy decision-making process. Accordingly, perhaps now is the right time for you to telephone me for a confidential, no-obligation discussion about how I can help you to put in place a realistic procedure for setting prices. I would be delighted to receive a call from you.

Please note this personal limitation. As a sole-practitioner, I simply cannot accept every assignment I receive. There are unfortunately not enough hours in each day. That’s why, if you can see the advantages of you and me working together, you must either email me or call me on (+61) 0404 631 230 . For fairness, I must operate on the ‘first up, best dressed’ principle. Why not call me now, this minute, and go for it!

Yours sincerely,

Graham  Segal

Chiron! the business doctor.™ ... relieves business pain!™ 

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© Graham Segal, Author. March 2013. All Rights Reserved

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This website and the associated webpages content are produced by Graham Segal trading as Chiron! the business doctor.™. They are licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 3.0 Unported License based on Graham's work at https://chironthebusinessdoctor.com.

Date this webpage was last reviewed/updated: 22 May 2013

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