Last modified:Wednesday 7 July 2021
Setting the right price for your products or services is a delicate balancing act. The competition, your production costs, but also the expectations of potential customers, are factors you should consider when setting the price. The price also influences the perception of the quality of your product or service, and consequently the image of your company. Improvisation is therefore out of the question...
THREE METHODS FOR CALCULATING THE "RIGHT" PRICE
1. Cost-based pricing
One common pricing strategy is based on the company's total costs (materials, production, labour, transport, administrative and accounting costs, sales costs, etc.). Just add up all the costs and you know the minimum amount you must charge so as not to make a loss. Then add a realistic profit margin to obtain your sales price. The benefits are obvious: it’s the easiest and safest way to avoid losses. On the other hand, costs are often difficult to predict or control (increase in raw material prices, regulatory changes, ...).
This approach is also far from complete: you may obtain a selling price but you have no way of knowing whether the customer is prepared to pay that price. Moreover, this approach is blind to the competition. If they undercut you, you have two choices: reduce your profit margins or develop other sales arguments.
2. Competition-based pricing
The basic principle is straightforward: you set your prices based on the strategies of your main competitors. This strategy is often used for products or services that have been on the market for some time and for which many alternatives or substitutes are available.
- If your products or services have similar characteristics to those of your competitors, the selling prices you offer should be close to those of your competitors.
- If you decide to set a lower price than your competitors, you must make sure that you are still able to break even! And watch out for the negative price spiral...
- If you set a higher selling price than your competitors, it must be justified by competitive advantages, superior quality, a good reputation, etc.
The "follow the leader strategy" is a common practice here. In this case, the prices of the individual provider are aligned with the prices of a market leader or with other providers. Example: mortgage rates at banks
3. Customer-based pricing
This strategy focuses primarily on the audience that makes decisions based on price: your primary target group. What does it believe is a “fair” price? This strategy requires many customer surveys and will rarely produce completely reliable results. However, it also provides some undeniable benefits. It seems that you often can invoice a higher price than the initial one, in particular for products and services which customers purchase instinctively or for which there is practically no competition. If you can then add value to your offering, you will automatically justify the price increase.
The premium pricing strategy is a good example of this and is often used for luxury products. The term "premium" refers to a group of products for which consumers are prepared to pay a little more because they are more valuable to your client (e.g. Apple products).
FINDING THE RIGHT BALANCE IN PRICING
Start too low
It isn’t easy for new products and services to stand out in a sector in which competition is intense. In this case, an (overly-) low price can provide useful leverage to quickly grow your customer base. This is, for example, the principle of the penetration price strategy. The aim is to acquire a large market share in a short time, even if the company must make do with a smaller profit margin (temporarily). Once you have reached the market share you want, you can gradually increase your prices and your profits.
The "stay-out" price strategy also starts at a low level: with this strategy, one tries to occupy the new market by asking such a low price for the product that it is no longer interesting for the competitor to enter this market.
Caution: these aggressive price-setting strategies require a solid financial foundation and a well-thought-out long-term plan because your profit margin will be low in the beginning. In addition, you risk losing customers each time you adjust your prices.
Start too high
This method - also called skimming - is used primarily for the launch of innovative products or services in the marketplace. By applying (overly-) high prices in the beginning, you will create a sense of exclusivity within your target group. What’s more, you will always have customers who are willing to pay more when the brand provides them with a way to stand out from the crowd. You can lower your price over time to also target less well-to-do buyers. The price of your product or service will eventually reach a competitive level. You will earn a lower profit per sale, but you will draw more (potential) buyers.
There is no single right way to set your prices. It depends on what you are selling, where you are selling it, to whom... So, try the three methods above, but remember that you are selling your products or services to people. Therefore, you should use a strategy that is tailored to your target group. The "right price" for your product or service is the highest possible price that customers are willing to pay.
What you need to keep in mind is how quickly you will break even at certain prices. Calculate this for the worst- and best-case scenarios. Also make sure that you have enough financial reserves to bridge the period until the break-even point.