The amount you charge for your products or services is one of the most important business decisions you will ever make, so it is surprising that many companies do not carry out regular reviews of their product pricing process. Having them too high or too low can result in difficulty generating revenue or extremely thin margins. At best this can limit your growth potential and at worst it could cause serious financial issues.
If a company is in its relative infancy, there simply won’t be any data available to carry out your own primary research. This means that you will have no real alternative but to analyse the market and use information garnered from your competitors. As it becomes more established, however, it should start collecting and using its own data – so it can develop a much more personalised strategy.
When reviewing your product pricing process, it is essential that you ensure the sales levels and prices you set will allow your company to be profitable. It is also important to gain a thorough understanding of how your products or services compare to the competition.
What is a Product Pricing Process?
Put simply, a pricing strategy involves deciding how much a company wants to charge for their goods or services. Selecting the right price requires a deep understanding of your products, your market and your clients.
There are many commonly used pricing strategies that can be utilised to separate yourself from the competition. These include price skimming, penetration pricing, premium pricing, economy pricing and psychological pricing. However, there are three main methods that are employed by the majority of companies, which are:
Cost Plus Pricing
This is the simplest and oldest way to determine a product’s price. It embodies the basic concept of making something, then selling it for more than it cost to make it in the first place. In practice, however, it basically involves a business plucking an arbitrary figure out of thin air – with no research being carried out whatsoever.
Its simplicity lies in the fact there is no need to keep an eye on consumer demands and competitor strategies or undertake any market research. The fact that you are already covering your manufacturing costs and then some means you are also guaranteed to make a profit on any product you sell.
Overall though, this product pricing process isn’t very efficient. Not only does it help create a corporate culture of isolationism, it doesn’t take into account any ounce of customer perspective. Therefore, it should only be used in extreme situations where you absolutely have no time to carry out the necessary research. Ideally, however, you should never be using this at all.
Competitive Based Pricing
Competitive based pricing is almost the opposite of cost plus pricing. Where cost plus pricing doesn’t take into account your competitors, competitive based pricing relies on the efforts of your competitors and the research they have carried out themselves – or, at least, you assume that they have.
Also known as strategic pricing, this method involves looking at the pricing structures of other companies in the same sector as yourselves and then adopting these numbers, plus or minus a few percent. This strategy has a marked advantage against cost plus pricing, since there is actually some form of research being carried out. Of course, this relies on you trusting that they are actually in tune with what’s happening in the market to begin with.
Competitive based pricing is a relatively low risk product pricing process, given the fact that it accounts for market share and other factors – meaning that it can be fairly accurate in some cases. However, it can lead to huge missed opportunities, since firms that adopt this strategy will often fail to realise the value of their own products or services and instead get stuck in the proverbial race to the bottom.
Value Based Pricing
The final major pricing strategy to explore is value based pricing. This involves using consumer data to determine your clients’ willingness to pay for your products. Customers typically will not care how much your items or services cost to make/provide, nor about the research your competitors will have carried out. Instead, they will mainly be focused on how much value they are receiving.
Basing your research and pricing structure on actual customer feedback provides you with real data and helps you develop higher quality products and improve client loyalty. It also provides you with the greatest amount of information about how you can use your pricing strategy to maximise profits.
The major downside of value based pricing is the amount of time, effort and resources necessary to make it a success. It is not simply a ‘one and done’ exercise, and instead needs to be something that is reviewed constantly to ensure the data is still relevant. However, it is arguable that a high-performing business should be seeking this kind of feedback from its customers anyway.
How to Review your Product Pricing Process
While it is true that no two businesses are ever the same, and each one will operate in entirely different environments, there are several steps that all companies can take to ensure their pricing structure is correct. Here are just a few:
Look at Hourly Costs
When trying to work out your hourly labour rates to charge customers, it is essential that you have a thorough understanding of what your costs are. To get a good idea of these costs, add up all the salaries of your employees and their benefits, together with your total overheads such as utilities, rent and taxes.
Once you’ve arrived at a final figure, divide this by how many chargeable hours your employees work each year. This will provide you with your average cost for each chargeable hour. You should also add your profit mark up to this.
Research Industry Mark-Ups
A good way to work out how much to mark up your employee and input costs is to find out what other businesses in your sector are charging. This is because they are largely based on industry standards.
While your individual circumstances may be different, having an idea about what the competition is doing will give you a good idea of whether or not you are on the right track.
Monitor Input & Supply Costs
The cost of raw materials tends to fluctuate along with economic cycles. During times of peak demands, some of these materials might even become more difficult to obtain – making them even more expensive thanks to the rule of supply and demand.
These fluctuations in costs should influence your product mark-ups and your eventual profit margins, so it is important to regularly monitor material availability and costs to ensure you remain up-to-date on what you should be charging.
Get a Thorough Overview of Your Business
Conducting a review of your product pricing process is just one of many things you should do to get a complete understanding of the health of your business. These include monitoring your supply chains, production costs and plant and machinery leasing agreements.
Reviewing all of these will provide you with a fantastic opportunity to identify ways to save money and highlight any potential pain points. This is where Inquesta can help. We’ll conduct a thorough overview of your company and point out areas of improvement that are designed to put you in a more secure financial position. We can also assist if your business is currently struggling.
For more detailed information about how Inquesta can help your company, book a free consultation or contact our team today.