Art Of Pricing

1. Pricing is about capturing value, not just covering costs

For most businesses, pricing is a profit-leaking paradox.

Value-based pricing. Many companies mistakenly base prices solely on costs, missing out on significant profits. Instead, pricing should focus on capturing the value customers place on a product. This approach allows companies to set prices that reflect what customers are willing to pay, rather than just covering production costs.

Hidden profits. By shifting to value-based pricing, companies can uncover substantial hidden profits. For example, when Emerson Electric implemented a value-based pricing strategy, they discovered customers were willing to pay more than anticipated for their products. This led to higher prices and increased profits without negatively impacting sales.

Pricing power. Understanding and leveraging the value customers place on your product gives you pricing power. This allows you to set prices that maximize profits while still providing value to customers. Companies should continually assess and adjust prices based on customer perceptions of value, market conditions, and competitive landscape.

2. Different customers have different valuations for the same product

The number-one theorem in pricing is that your competitor's price affects how consumers value your product.

Lessons from an auction. Just as bidders in an auction have different maximum prices they're willing to pay, customers value products differently. This concept, "lessons from an auction," is fundamental to effective pricing strategies. Understanding this allows companies to capture more value from customers who are willing to pay more.

Factors affecting valuation:

• Income levels
• Availability of substitutes
• Product characteristics
• Market environment
• Personal preferences

Multi-price mindset. Recognizing these varying valuations, companies should adopt a multi-price mindset. This approach involves offering different pricing options to capture value from customers with different willingness to pay. For example, airlines offer various fare classes to cater to different customer segments, from budget-conscious travelers to those willing to pay premium prices for added comfort and flexibility.

3. Create a culture of profit by empowering employees with information

There are few things more satisfying than watching an entrepreneur who endured the hardships that came with making her vision a reality experience the thrill of gaining consumer acceptance.

Transparency and education. Creating a culture of profit starts with sharing key information with employees, particularly the sales force. This includes:

• Product profitability data
• Operating margins
• Value propositions for each product

Empowered decision-making. When employees understand how their actions impact profitability, they can make better decisions. For instance, a sales representative who knows which products have higher profit margins can focus on promoting these items, ultimately boosting the company's bottom line.

Aligned incentives. Ensure that employee performance metrics and compensation structures align with profitability goals. This might involve revising commission structures or implementing profit-based bonuses. Regularly review and adjust these policies to maintain a strong culture of profit throughout the organization.

4. Use differential pricing to serve customers with varying valuations

Differential pricing allows you to sell your product at different prices to different customers.

Strategies for differential pricing:

• Customer characteristics (age, gender, affiliations)
• Hurdles (coupons, memberships)
• Time-based pricing
• Quantity discounts
• Distribution channels
• Negotiation

Identify customer segments. Differential pricing requires understanding different customer segments and their willingness to pay. For example, movie theaters offer discounts to students and seniors, recognizing their lower willingness or ability to pay full price.

Implementation considerations. While differential pricing can significantly increase profits, it's important to implement it carefully to avoid alienating customers. Ensure that price differences are justified and not perceived as unfair. Use tactics like coupons or memberships to create a sense of exclusivity or reward for those receiving lower prices.

5. Version products to attract different customer segments

Versioning is a multi-price mindset strategy that involves selling similar products to different customers at different prices.

Good, better, best approach. Offer multiple versions of a product at different price points to cater to various customer segments. This allows customers to self-select based on their willingness to pay and desired features.

Versioning techniques:

• A la carte options
• More is better (premium versions)
• Less can be profitable (stripped-down versions)
• Add or subtract features
• Expedited service
• Avoid the wait (priority access)
• Uncertainty (risk-sharing options)

Attract new customers. Versioning not only helps capture more value from existing customers but can also attract new ones. For example, offering a basic version at a lower price point can bring in price-sensitive customers who wouldn't have purchased the full-featured product.

6. Implement segment-based pricing to activate dormant customers

Segment-based pricing is a multi-price mindset strategy that activates dormant customers by employing new pricing strategies.

Innovative pricing models:

• Interval ownership (e.g., timeshares)
• Bundling
• Leasing
• Prepaid options
• Rental
• Two-part pricing
• Payment plans
• Customized pricing
• All-you-can-eat pricing

Unlock new markets. These pricing strategies can open up entirely new customer segments. For instance, interval ownership in the private jet industry made luxury air travel accessible to a broader range of customers, dramatically increasing industry sales.

Address specific customer needs. Each pricing model addresses different customer preferences or constraints. For example, prepaid options appeal to budget-conscious customers who want to control their spending, while leasing caters to those who prefer lower upfront costs or regular upgrades.

7. Apply strategic and psychological touches to refine your pricing strategy

The final step in any Value Decoder analysis is to identify potential substitutes for your product.

Strategic considerations:

• Create publicity through pricing
• Ensure the right customers get your product
• Promote repeat business
• Fit customer perceptions of price levels

Psychological pricing tactics:

• The nine and zero effect
• Payment structure to promote satisfaction
• Prestige pricing
• Anchor pricing
• Quantity-suggestive pricing
• Framing large versus small losses
• Bundling to convey value
• Appealing to bargain-hunting instincts

Balancing act. While it's crucial to capture value through pricing, it's equally important to consider the strategic implications and psychological impact of your pricing decisions. For example, sometimes setting a lower price can generate valuable publicity or ensure that loyal customers can access your product, ultimately benefiting long-term profitability.

Last updated: October 19, 2024