WHO SETS YOUR PRICE?
I recently had several conversations about price. Specifically, how can you set price. Sure, if you ask an economist they will say that supply and demand sets the price. If you asked a marketer, she would say that the customer will set the price. A manufacturer would ask that the price always be set above the break-even cost of the product. And if we asked the sales team, they will always look for our best available price to make the sale.
SUPPLY-DEMAND PRICE CURVES
Let’s look at the subject in more detail. For a product like gasoline, using supply-demand curves makes a lot of sense. The optimum price is set at the intersection of an upward sloping supply curve and a downward sloping demand curve. From a practical perspective, this means that you need to price your product such that you optimize the price-volume of the product. If the price is too high, sales volume will shrink and revenue will decline. If the price is too low, volume may be high, but the revenue stream is not optimized.
Great! So what does that really mean? For gasoline, it is all about adjusting your price relative to your competition. A savvy gasoline station owner will adjust price based on both supply side market conditions (cost of crude oil / gasoline) and demand side conditions (competitors). As the price of crude oil changes, the owner will adjust the price up or down. However, they must always keep an eye on competition across the street. Gasoline station owners know that consumers have choice. If the price is too expensive then we will defer a fill-up until we find a better price. Daily sales volume will dictate whether the owner should increase or decrease price relative to competition.
MARKETING A PREMIUM PRODUCT
Not every product behaves like gasoline. Let’s examine the headphone industry. There was a time that headphones were considered almost a commodity product that was rarely priced above $20. Today, headphone prices range from $20 to over $500. Manufacturers changed the features and benefits of headphones—and therefore price according to value in the market. Noise cancellation, wireless Bluetooth capability, high end and low end bias, mute, volume control, etc. are all features that can create value in the market.
Costs have nothing to do with the price of headphones. What is the value of the additional feature in the minds of the consumer? How much will the consumer pay for each feature? Marketing managers will spend time and market research to determine the proper value of each feature that will be launched.
Manufacturers that can enter this “New Market”, first, have the advantage. This is known as the “First Mover Advantage”. They can dictate the value of the features relative to the existing norms. However, ultimately competition will enter the market and begin to erode some of the advantages. Over time, manufacturers will need to price their premium products relative to competition.
PRICING FOR SERVICE
If anyone has contracted for HVAC installation lately, they know that the cost of the air conditioning or heating units is only part of the cost. Unless you are extremely handy, you are going to have your contractor install the units. Pricing for this service varies from company to company and from brand-to-brand. Pricing for service installations is very similar to pricing any product for large volume national accounts. So what are some of the pricing considerations for this type of service?
First, the business owner will have a very precise idea of the product, labor, and overhead costs for the installation. A savvy business owner will be able to break his cost basis down to fixed costs (overheads, labor, depreciation, amortization, etc.) and variable costs (unit cost of goods sold, materials, fuel costs, delivery costs, etc.). The owner will also understand how many installations have been installed for the season and whether that puts the business ahead or behind a break even cost point.
Obviously, if an owner can price his product above both fixed costs and variable costs they will be adding to profitability for the business. However, let’s assume that this has become a highly competitive market. How low can you price the service? For incremental business, pricing theory suggests that if you can price the product above your variable costs, then you can still make money for the business—as long as your incremental volume is above your break-even volume. Sounds confusing, but the figure(s) below may provide additional insight.
To summarize, the pricing function is both an art and a science. There are some fundamental models that can be used to aid in pricing. However, those models can be thrown out of the proverbial window if a marketer can capture additional value by adding features and benefits to the product. For some products / services, understanding fixed and variable costs can have a profound impact on your ability to price incremental business. Finally, in all scenarios discussed today, you need to consider your competition—today and into the future—when pricing your products.
About the Author: Garrett Grega is a Certified Business Coach with FocalPoint Business Coaching in Branchburg, New Jersey, where he specializes in reconnecting executives, business owners, and managers with their business passions! He has 20+ years helping international companies launch new products and processes. He previously spent 8 years launching LED lighting products for various lighting companies. His professional experience includes: strategic planning, business development, marketing, and product development. See more at www.garrettgrega.focalpointcoaching.com