Do You Have a Pricing Strategy
One of the most important topics for small business is how they price their products and services. Prices have to be such that they are competition-based and cost-based (profitable). However there is a third part of the pricing strategy that is critical. Prices have to be market based. The market must want to buy what businesses are offering at the price they are offering it.
The basis for market-base pricing is understanding that the market buys perceived value.
Value can be described by a simple formula that is complicated in reality. The formula is Value = Quality/Price. Something has value to us when it has a certain quality us and doesn’t cost too much. Notice that quality is capitalized and means any reason we purchase this product or service. In a product, quality could be durability, color, functionality, maintainability, style, appearance, etc. In a service it could be convenience, flexibility, customization, friendly, dependable, relevant, etc. It is, of course, the reason we make the purchase.
Also note the word “perceived”. A customer buys something that has value to him or her. It may not have value for someone else, but it does for this customer or group of customers. This is, in fact, how businesses segment their market. They find this group of customers, which becomes the market niche that small businesses need.
So, what good is this little formula? It provides the framework for designing your product or service and pricing it. Your business offering must provide value to your customers. How do you raise value? The formula says it’s simple. You either raise the quality or lower the price. In reality this is more complicated.
First of all how do you measure quality? Quality can be only a general perception or a feel. It must be quality that the customer wants, not what you want or think he wants. You must use market research to find out what the customer wants in a product or service. Then you try to raise quality with out raising your costs. If you have to raise costs, you would probably have to raise the price, which would lower the value.
Major breakthroughs can occur when you can raise the quality and lower your price at the same time. Sometimes you can raise the quality a lot and only raise the price a little. You have to be careful in this case, since you may move out of your market niche where your customers just don’t want to pay for all that quality.
One other way to increase value is to keep the quality the same but lower the price. The correct way to do this is to lower your costs first, and then lower your price. This way you maintain your profit levels. To just lower price without lowering costs is wrong for small businesses. Do not try to compete on price alone. Perhaps there are ways to lower your costs by volume purchases, technology improvements, partnerships, production changes, etc. If so, by all means then, and only then, lower your price
Sometimes you can remove more cost than quality. This, in theory, will increase value if you lower your price. However, if customers notice the lower quality, and they don’t like it, then you have moved out of your market niche and you probably will lose customers.
So, what does all this mean? For sure, your prices have to be competitive and higher than your costs. But try to understand market based pricing and how customers buy value. Make sure you understand the customer’s concept of value and not just your own. Then try to give them more value
This article was written by Seattle SCORE Chapter member Fred Parkinson for the Kitsap Sun in Bremerton.