How to price goods and services: ten FAQs

Ten FAQs on pricing.

1. How do I price my goods and services?
2. What's the relationship between price and costs?
3. Should I charge more or less than my competitors?
4. What do I do if my competitor starts a price war?
5. How can I increase prices without losing customers?
6. How can I predict the impact on sales of a higher or lower price?
7. Should I price one product low, as a loss leader?
8. Should I offer discounts or hold a sale?
9. What pricing tactics can I use for different times and different markets?
10. How often should I review my pricing?

1. How do I price my goods and services?

The right price for everything is easily defined. It's the maximum amount the customer is willing to pay for it. A good starting point is to look at how much your target customers are paying for alternatives to your product or service.

The first step is to pull together a representative selection of competitive and comparable products or services, and to prepare a list of all the features offered by each package. Few customers buy the product alone. People buy a package and this includes aspects such as: the brand name, personal service, quality, flexibility, reputation, range of options, location, delivery options, easy parking, technical advice and many other factors. A £3,000 used car from a small garage could be worth £4,000 from a bigger dealer.

The next step is to make an objective comparison, using these features lists, to help establish relative values to the customer. It is essential to be clear about what exactly you are selling compared with your competitors. Finally, ask people from outside the company for their opinions.

This process inevitably takes time but the impact on the bottom line, if you get it right, makes it worth every minute.

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2. What's the relationship between price and costs?

There is no relationship. Costs are facts and must be fully understood and managed. Prices are policy and have to be decided.

Customers know the value of what you are selling from their understanding of what is being offered elsewhere. You have to bolster the attractiveness of your offer with a clear presentation of features and benefits and set your price. If you have got it right, your price confirms the customer's evaluation and you may well make the sale. If your price is too high, the customer will get better value elsewhere. If your price is too low (as is often the case with smaller businesses), the customer may still buy elsewhere, for peace of mind.

If you generate huge gross margins, don't be embarrassed - you probably need the money to cover promotion and selling costs. If your gross margin is too small, you will have to either find a way of cutting costs or stop selling this product or service.

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3. Should I charge more or less than my competitors?

There are three issues to consider before you answer this question. What is your firm's image? What exactly are you selling? Who exactly are you selling to?

Image

Pricing is a powerful communication medium. Your prices say a lot about quality, dependability, confidence and professionalism. Your prices must be in line with your firm's image.

What exactly are you selling?

There is always a cheaper product or service down the road. But how does it compare with yours? You must consider all potential factors before you set a price, including aspects such as: technical advice, free parking, choice, delivery, availability, personal service, flexibility and reputation.

Who are your target customers?

What is cheap to one person may be expensive to another. Once you know who your customers are, you can create a package, including price, that is exactly right for them.

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4. What do I do if my competitor starts a price war?

It is essential to respond quickly, while using any means possible to avoid cutting your own prices. A ten per cent cut may be a lot more than your business can afford. Ultimately, you may be unable to avoid price-cutting, but you must consider other options. It is not uncommon for price-cutters to find themselves in serious trouble, so hold out as long as you can.

The first line of defence is to recognise that, although price is very important to a customer, it is unusual for the purchase decision to be made on price alone. What are the other important factors? Convenience? Service? Choice? Dependability? Personal service? Promote them hard as added value.

The second line of defence is to give something away with your product or service. This will ideally be something that has a higher value to the customer than its cost to you, such as an extended warranty, free delivery, a supply of consumables, a service at half price, or the opportunity to buy three items for the price of two.

If the only sales appeal you have is low prices, you could get into trouble. When prices hit rock bottom, the only remaining element for you to whittle away at will be the quality of your offering. So it is better to find another way of attracting solid business, either by providing better service (the preferred option) or being more innovative in your marketing.

Price wars are usually selective. Supermarkets may reduce the price of sugar, but they will recoup it on other lines. Remington's Victor Kiam ("I liked the company so much I bought it") put his prices up when under threat and spent the extra profit on marketing. Success soon followed.

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5. How can I increase prices without losing customers?

The appropriate answer to this depends upon the nature of your business. But there are several likely scenarios.

1. Many businesses offer an excellent package, are unclear about who the target customers are, and charge low prices. A comparison of what is offered with competitors' offerings reveals that a price increase is justified. The increase is implemented. Some customers are lost - the ones that will be satisfied by a lesser package. But new customers are gained - the ones who demand supplier credibility and are willing to pay for it. In this situation, it is common to achieve a net gain in volume.
2. Raise prices gradually, to a plan. Increases may be applied to a few products at a time.
3. Raise prices and provide a substantial loyalty discount (with a time limit) for existing customers.
4. Change the package and relaunch it as a new product, at a higher price. New product, new package, new perceived added value.
5. Accompany your price increase with demonstrably improved marketing and selling professionalism.

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6. How can I predict the impact on sales of a higher or lower price?

Experiment - but control it carefully to minimise risk.

The first step is to research your competitors and make an objective comparison between what they are offering and what your product or service offers. As far as possible, remove the guesswork and try to eliminate your own bias.

Now you should know how much price adjustment is required. The next step is a limited trial. Try it for a short time. Try it in a specific locality. Try it on a certain sort of customer. When a prospective customer declines, ask why and make a note of the answer. It may be nothing to do with price but be about something else which is not quite right.

Forecasting the impact on sales is always difficult, but should be done. Now forecast the impact of the price change on the bottom line - you could be in for a big surprise.

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7. Should I price one product low, as a loss leader?

Basic food items such as milk and bread have long been used as low-price staples to lure customers into supermarkets, in the hope that once there they will make more purchases. Used with care, loss leaders are a good way of getting noticed, particularly when targeting new customers. The hardest part of selling is to persuade new customers to switch from existing suppliers without a good reason. Try to source a line at a special price for this sort of exercise, by getting the supplier to share the cut with you, in return for increased volume.

Also study the pricing policies of your competitors - these could provide useful clues as to how you can pitch your strengths against their weaknesses.

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8. Should I offer discounts or hold a sale?

Discounts are a vital part of your pricing policy. They can help you to:

1. differentiate between market segments (trade and consumer);
2. encourage buyers to place bigger orders or to place an order immediately;
3. tempt buyers to buy a more profitable line ("ten per cent off X, when you order Y").

If you are selling through intermediaries (agents or wholesalers), then discounts off the recommended retail price are the established pattern of trade. If you are in the confectionery trade, for example, it is called POR (price off retail): learn the jargon of your business sector.

Sales are used to clear old stock, make way for new lines or generate cash from slow lines. Cash in the bank is usually better than over-valued stock on the balance sheet or in the store room.

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9. What pricing tactics can I use for different times and different markets?

Most tactics revolve around discounts and special offers, or added value.

Added value: The usual ploy is to add something special into the package - a large number of options, an enhanced guarantee, delivery, service, credit, or special branding, packaging or presentation. In some markets, these devices are useful to hold prices up against fierce competition. In others, they can be used to justify higher prices than the competition.

Discounts and special offers are an effective way to stimulate business or to move stock quickly. It is important to have clear objectives, to qualify your offer and to promote hard. The discount should be for a limited period only. So should special offers, as they soon get tired.

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10. How often should I review my pricing?

Most firms do an across-the-board price review every year. But there may be other, more urgent, occasions. The trigger could be:

• a threat, such as the arrival of a new competitor;
• a fresh opportunity, such as a change in legislation or technology;
• the need to boost flagging sales;
• demand from an unexpected quarter.

In practice, your pricing policy should be kept under constant review to take advantage of market opportunities and ensure you make a decent profit.

Competitors' pricing should be kept under continuous surveillance. In practice, this can all too easily be overlooked so it is worth establishing a regular price-checking routine.

A review is not a price change, of course. Every opportunity should be taken to avoid price erosion. Your review may conclude that a price reduction is unavoidable, but it is better to delay if at all possible and bridge the gap with new deals, special discounts or initiatives that add value to the package. One company cannot have a price war all on its own.

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