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Pricing is one of the four “P’s” of the marketing mix. It is a marketing variable that can play a significant role in the success or failure of a product. As a product manager (the person who typically sets pricing), you will need to consider most of the following items in order to have an effective pricing model:
- Understand the rate card price (US and International), the pricing models (exceptions, bundles, forward pricing, etc.) and the overall “cost” of deployment for every competitor.
- Know the pricing models that work within complimentary markets. For example, if you are selling desktop publishing software, you may also wish to know the pricing for other desktop publishing products and take it into account.
- Understand the overall cost and pricing of alliances and others that help create the “whole” product. By understanding your complimentary products, especially alliances that are competitors of each other, you may reduce your customer’s overall cost by suggesting that they choose a different product. In desktop video, if the customer only has 100k to spend, rather than reducing your price, you may recommend that they get the savings by selecting a different camera, 3D package, etc. This information helps you deliver the “whole” product at a competitive price without eroding your pricing.
- Know all of the pricing issues that face our customers. Understand where we can help our customers find pricing relief within the entire “system”—not by just discounting our own product. See above.
- Establish and continually refine the pricing models and the overall-pricing matrix. Provide pricing information such as the following:
- Published rate cards for sales (either an MSRP, or some equivalent standard pricing).
- Exception policies and examples (i.e., you are willing to allow the 100k unit pricing, if the customer gives you an exclusive for the remaining 100k units that they may purchase (forward pricing model)
- OEM pricing by components
- Alliance pricing (you want your alliances to have your demo equipment and you may wish to discount it for their non-resale use).
- Sample (NFR) pricing for resellers.
- Support pricing and maintenance agreements
- Upgrade pricing for existing customers. For example, you may list the latest software release for $599, but sell the upgrade for $99 to existing users.
- System Integrator & VAR discount schedule – varied according to their authorization level.
- Peripheral and component pricing (with/without the software, keyboard, customizable remote, game controllers, etc.).
- Alliance add-on product pricing. You may wish to cross-sell each other’s products and enable both sales teams to have bundled pricing.
- Both US and International/localized pricing matrix
- Create “Price Savings Build-up,” and “Reduce to Simple,” “Price vs. Cost,” examples, along with “what works best” pricing dialogues from the field.
- Disseminate this information regularly whenever it is updated.
Price enables us to make the appropriate margins to run a successful business–over the life cycle of the product (not always up-front). It is also a means of distinguishing our offering from those of competitors–positioning. In addition, the price is a tool for communicating with customers and influencing the way they buy. The four components of a pricing program include 1) objectives, 2) strategy, 3) structure and 4) price levels.
There are over twenty pricing objectives that we might consider. Following are four that I typically concentrate on:
- Target market share. The objective for this strategy is to maximize market share–sometimes at the cost of maximizing early profit.
- Target return on investment. This strategy attempts to maximize the return on investment.
- Sales growth. This is similar to maximizing market share, except it is expressed in the difference in sales over time.
- Maximize long-run profit. This strategy is not dependent on making a “quick buck,” but rather with making the most from a product during it’s entire life cycle.
We would typically include a description here as to which of the objectives we favor and how we expect to apply them.
Pricing strategies fall into one of two categories: market-based and cost-based. Market-based strategies include the following*:
- Floor pricing. Charging a price that just covers costs. This approach is usually selected to maintain a presence in the market given the competitive environment.
- Penetration pricing. Charging a price that is low relative to a) the average price of major competitors, and b) what customers are accustomed to paying.
- Parity pricing (going rate). Charging a price that is roughly equivalent to the average price charged by the major competition.
- Premium pricing (skimming). The price charged is intended to be high relative to a) the average price of major competitors, and b0 and what customers are accustomed to paying.
- Price leadership pricing. Usually involves a leading firm in the industry making fairly conservative price moves, which are subsequently followed by other firms in the industry. This limits price wars and leads to fairly stable market shares.
- Stay out pricing. The firm prices lower than demand conditions require, so as to discourage market entry by new competitors.
- Bundle pricing. A set of products or services are combined and a lower single price is charged for the bundle than would b the case if each item were sold separately.
- Value-based pricing. Different prices are set for different market segments based on the value each segment receives from the product or service.
- Cross-benefits pricing. Prices are set at or below cost for one product in a product line, but relatively high for another item in the line which servers as a direct complement (e.g., certain brands of cameras and film).
Cost-based strategies include:
- Markup pricing. Variable and fixed costs per unit are estimated, and a standard markup is added. The markup is frequently either a percentage of sales or costs.
- Target return pricing. Variable an fixed costs per unit are estimated. A rate of return is then taken times the amount of capital invested in the product, and the result is divided by estimated sales. The resulting return per unit is added to the unit costs to arrive at a price.
Exercise: At this point, you would typically create a grid showing your products, the price objective, strategy and margin.
Below is a video (from Chanimal’s Alma Mater (BYU)) that shows how pricing strategies can be one of the primary differentiators for a company. Very engaging video format.
Implementing a pricing strategy requires a pricing structure. The structure determines
- Which product or service will be priced
- How prices vary for different customers and by products and services and
- The time and conditions of payment.
Price levels refers to the actual price charged for each product or service. these prices can vary according to product cost variations over time, the desired value perception, the width of price gaps between options or between volume breaks, and the demand sensitivity (elasticity) within the price range. Pricing levels can also be changed through promotions to reduce inventory, or encourage adoption of new add-on services. Pricing levels would typically be found within the price matrix.
- Click here for an example of how pricing is applied within the marketing plan.
- Click here for an entire site dedicated to Software Pricing.
- Wilson Web has a good article on pricing within the context of a marketing plan that is very similar to the information above.
* Several pricing strategies above are expounded on within the book from Michael Morris, Market Oriented Pricing, Illinois, NTC Publishing Group, 1995 (highly recommended)
Price Savings Buildup
Whenever you list your pricing, you should always do a price savings buildup. This is where you show how your price is “justifiable” based on the competitive or alternative options. You are not finished with pricing until you have created the dialogues needed by sales to justify your pricing. Without duplicating content, you can read about these dialogues in the Chanimal online sales manual here.
More Pricing Topics (all go to same page)
- Price Matching
- Introductory Pricing
- Competitive Pricing
- Student Pricing
- SRP versus Street Pricing
- Selling Value – Not Price
Definition – Difference between “Points” and “Percentage”
Often in distribution, you hear the term, “points.” For example, I gave my distributor 50 points (it refers to point mark-up). Although often thought of as the same, it is not the same as a 50% margin. The problem comes from the difference between markup and margin (also called gross profit). Mark-up is the percentage of the amount you earn on the cost of an item you sell. Gross profit (or margin) is the percentage of the amount you earn on the selling price of the item. Here is how to compute it:
- You purchase the software from distribution at $50 and sell it in retail for $80–or $30 above cost. Divide the earnings ($30) by the distributor price you paid ($50) and you get 60%–that’s your % mark-up on the cost.
Gross Profit (margin)
- You purchase the software for $50 and sell it in retail for $80–or $30 above cost. Divide the earnings ($30) by the selling price ($80) and your get 37.5%–thats your margin or gross profit on the selling price. This means you earned 37.5 cents on each $1 of sales–to meet your expenses of operation and net profit, if any.
Put another way, gross profit margin is figured on the sales price of an item, and the markup is based on cost. Historically, retailers used the markup method to determine the sales price while manufacturers used the gross margin method. However, in today’s retail environment, both terms are often used interchangeably to mean gross margin.
The markup method involves increasing the price of an item by a certain percentage over cost. For instance, software that cost the company $100 wholesale would be offered for retail sale at $126 if the store had a 26% markup on cost (multiply the markup percentage by the cost and then add the result). The gross profit margin on the sale is figured by subtracting the cost ($100) from the sales price ($126) and then dividing the result ($26) by the sales price ($126). In this case, that produces a margin of 21%.
Here is another explanation that may help from QuoteWerks.