Author: Shankar Meembat, The Alternative Board (Milton Keynes)
What are different business pricing strategies?
Many business leaders will ask: What should be the pricing strategy for my business’ service or product? The most typical answer is – it depends. Pricing strategies in business do depend on a large number of circumstances. If you’re a start-up, you might be interested in knowing the seven business pricing strategies every new entrepreneur should know. But if you eliminate some market factors there are essentially two ways of determining the pricing of a product or a service: it’s either cost based or value based.
Cost based pricing essentially means you determine the cost of creating and delivering the product or service. And you add on a margin to set the price for your customer. Cost based pricing is great because of its simplicity. Though it’s not without its pitfalls.
There are primarily two things that you need to watch out for in cost based pricing:
- It’s difficult to determine what exactly is the cost. Direct labor and material is easy, but what about overheads?
- The uncertainties to the cost, which could come from for example a delay in shipment. It makes it very difficult to cater for those uncertainties into your price and it can hit your margin.
Value-based pricing on the other hand, depends upon the value that your customer perceives about your product or service. Thus it’s not affected by some of the factors I mentioned about.
In most cases, value-based pricing is higher than the cost based pricing. And hence often better for your profitability.
While value-based costing does solve some of the pitfalls of cost based pricing, it adds one big element of complexity. And that is a question of how to determine the value of your product or service to the customer?
Which of these pricing strategies should I use?
The answer not surprisingly is, it depends. If you’re in a competitive market with little differentiation, then cost based pricing is possibly the answer. However that is not sustainable as invariably someone else will come in with a lower cost. Which means that in almost all situations, value-based pricing is a better option for you.
How do I create a value-based pricing strategy?
I’d like to summarise it as determining the WORTH of your product.
W which stands for understanding Who your customer is. Since it’s a customer’s perceived value it’s important to be able to focus on exactly who you are trying to serve.
O is for the customer Opinion or perception. Remember you don’t define the value, it’s the customer that does, so the opinion of the customer is crucial.
R stands for market Research. Which is absolutely crucial to understanding what your customer is willing to pay.
T is for Transmission or communication of your value. It’s not just about sticking a price label on, it’s about making sure the value is communicated in the customer service, in your branding, in your messaging and so on. In fact, a strong brand equals strong profits so it worth considering this in detail.
H is for Huddling or bundling features into your product. Such as an extended warranty that gives higher perceived value to the customer, without necessarily increasing your cost.
So if you’re using cost based pricing today, consider the worth of your product and look at how you could shift to a value-based pricing strategy. If you’re still struggling, you could consider working with a business coach and mentor who can help you with your strategic business planning and advise on the best pricing strategy for you.