October 19, 2010

Your pricing strategy can make or break your company

I’ve been very busy recently working with several clients, one of which needed strategic assessments of entering the Smart Grid market. And a big part of the assessment had to do with the pricing model for this new vertical.

As you can imagine, pricing model has a direct impact on the top-line, the bottom-line, and sales volume, and can effectively make or break a company – or make it float around in mediocrity, as is sometimes the case.

Before I get into details, I should say that I have no background in consumer goods where pricing is a whole different beast to tackle. I have no idea how the following applies to consumer goods, though I suspect the general principles apply to business uniformly.

Market-based vs. cost-based pricing. Amazingly, some companies still base their pricing model on their cost. Here’s my comeback to this concept: whether a product costs you $100 or $1,000, if the market pays $800 for it, that’s where you should price it. Otherwise you’re either leaving money on the table or pricing yourself out.  If you can’t make the desired margins, you need to create value, change your target market, or change your offering.

Creating value. The market pays for value, and you can’t expect it to extract the value from your offering without your help. Every target demographic needs to be considered in creating the value. Whether it’s the ‘cool’ factor, functionality, reliability, time-savings, cost-savings, or otherwise, clearly communicate the value to each set of your demographics. Products don’t sell themselves, people sell them – and they do it by creating value. Tactful positioning comes in handy for creating value. Apple is a company that consistently does a great job at creating real value (great products) plus perceived value (cool factor).

Competition. It shouldn’t be a surprise that if there’s little competition in your market, you can charge higher for your products and services. Needless to say, you need to continually monitor your market for competition. And if your market finally does get targeted by competition, value creation will help you edge ahead of them.

Price wars. Alternatively, in markets with a lot of competition, it’s easy to fall into the “price war” trap. This is typical in commoditized markets, or those in which innovation has worn off (like the PC market). The best way to avoid price wars is to add value, reposition, or accelerate innovation. Without continued innovation, value eventually wears off. Sometimes it’s not worth staying in a market with continual price wars, and it’s best to get out. IBM got out of the PC business mostly for this reason.

Growth markets vs. established markets. The general rule is that growth markets afford higher prices. Market excitement, lack of competition, and the general “first to anything” mentality with growth markets allows for higher prices. Don’t be afraid to use this to your advantage. Eventually, with additional players and sizzle fatigue, prices will go lower.

If in doubt, start high. If you’ve been in the business long enough, you probably have a pretty good idea of the price the market will bear, but in new verticals, this can get tricky, and sometimes it becomes difficult to figure out a good pricing model. When in doubt, start high. The market will quickly let you know if you’re overpriced and you can always lower your prices, but increasing your prices will be much more difficult.

The market talks back – only if your price is too high. As I mentioned, the market will quickly let you know if you’re overpriced. Here’s the trick, it will hardly ever tell you if you’re under-priced. You could be happy selling high volumes of your products not realizing that you’re leaving 20% on the table. How about implementing a better pricing model that will increase your top-line by 20%, or add 50% to your net margin?

Life-cycle pricing. This topic deserves its own article, but it’s important to keep an eye on the market as the product or service grows, picks up momentum, and nears its “end of life”. The product or service needs to be actively re-priced throughout its life-cycle from launch, mid-life, to end-life. For example, production costs or support/maintenance costs could be much higher for older products or services, causing the margins to deteriorate with lowered pricing. Continual business analysis can bring this to light in order to shelf older products and services, and charge more for newer ones.

Lastly, don't be afraid to charge higher for your products and services. Create value and don’t leave money on the table. Remember, you can always lower your prices, but increasing them is much more difficult.

I’d love to hear your stories of pricing genius or mishaps.

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