The ability of any business to make money depends on many different factors, including its industry, customers, marketing strategies, and the market forces of supply and demand. Another key factor that also influences a company’s ability to make a profit is pricing.
Why does pricing matter for a company/firm?
One reason is that the prices of products define their worth, and determine what value the customers can expect to receive by purchasing them. Moreover, prices influence how much money a firm can make and determine the profitability of the firm. A profitable firm is more likely to remain in operations and create more future opportunities to generate profits.
And yet, many companies don’t put much time, effort, or energy into setting their prices, which is why they often lose out on profits. Here, an organization can use many strategies and models that can help them set the “right” price for product offerings to boost revenues, and ultimately, maximize profits.
5 Common Pricing Strategies to Consider
The price of a product is subject to multiple factors, including production cost, profit goals, customer demand, and market trends. The product’s positioning and branding strategy also play a role, as do psychological factors (customers are most likely to pay for a product with a price little less than the round number). Some of these factors may be uncontrollable for a company. Nonetheless, the best a firm can do is to choose the right pricing strategy.
Here are 5 strategies to consider:
Cost-plus Pricing
Cost-plus pricing is probably the easiest pricing strategy to apply. In this, simply add a desired margin/markup to the production cost to determine the price.
Price = Production Cost + Markup
Make sure to consider all the costs, not just the cost of manufacturing. Calculate the cost of distribution, labor, machinery, material, warehousing, utilities, etc.
To compute production costs, calculate:
Unit Cost = Total Cost + Number of Units
Price = Unit Cost + (Unit Cost x Markup Percentage)
This strategy can work well for retail companies that know their production costs and charge different prices for different products.
Best when: Production costs are known
What the Market Will Bear (WTMWB)
Another common pricing strategy is the WTMWB approach, where the price is based on the maximum price the market will pay for it. Of course, to understand this, a fair amount of market research is required.
WTMWB works best for new and unique products that are likely to attract early adopters and non-price-sensitive buyers. If the products are new, the WTMWB strategy can help build market share, establish a leadership position, and realize high profits in a short time. But if a product is commonplace and already has a lot of competition, WTMWB pricing may not work.
Best for: Companies that don’t have a lot of competition in their industry because the product is new or highly innovative
Gross Profit Margin Target (GPMT)
The GPMT strategy is ideal when a company already knows the cost of its product and has also determined its gross profit margin target (GPMT) to generate positive net income and cash flow. The strategy is ideal for product wholesalers, retailers, and manufacturers.
GPMT = Price – Cost of Sales
Price
GPMT can be anywhere from 10% to 50%, depending on whether the firm is a wholesaler, retailer, or manufacturer. Among the three groups, manufacturers usually aim for the highest GPMT, followed by retailers or dealers, and then wholesalers or distributors.
A manufacturer aiming for a GPMT of 50%, will calculate the price = 2 X Cost (P = 2C). Whereas, incase of a retailer or distributor, GPMT may be different, and one should calculate the price accordingly.
Best for : Product manufacturers, retailers, and wholesalers
Most Significant Digit (MSD) Pricing
Previously, a glimpse was shown of how psychological factors influence the customer’s willingness to pay for a product. For example, customers are more likely to buy products whose prices end in the number nine.
Hence, the consumer product companies take advantage of such factors to employ the MSD pricing strategy. So, they may price a product at $14.99 or £299.95 instead of $15, or £300. This strategy takes advantage of a human psychological quirk, wherein people focus on the “most significant digit” – 1, and 2 in the above examples – so the price appears a lot smaller which encourages a buyer to shop more.
This strategy works especially well for consumer products because these customers are often price-sensitive, and the products are not that different from each other. The approach also works well in real estate where a home priced at $2,995,000 sells faster than a home priced at $3,000,000.
Best for : Consumer product companies
Competitor-based Pricing
Competitor-based pricing is a strategy in which a firm “copies” its competitors’ prices.
This strategy is most useful for similar products, but not for unique products. Thus, if the products compete on price alone, and not on the basis of innovative features, advanced capabilities, or quality, consider competitor-based pricing. The strategy is easy to apply – simply find the prices of similar goods in the market, and then a firm should apply them to its offerings.
The drawback is a lack of flexibility. In case, if the customer base is highly price-conscious, a firm cannot make sudden pricing changes without suffering a loss of sales, revenues, and profits.
Best for: Companies or products competing on the basis of price alone
Conclusion
Every pricing strategy narrated above has its own significance. One strategy can make a huge difference in dollars. Thus, it is imperative for a firm to understand which pricing strategy works best in favor. This can have a powerful impact on your revenues and profits.
For almost 15 years, Ergode has empowered dozens of high-performing companies to accelerate their e-commerce growth with the right pricing and sales strategies. Contact us to know how we can take a firm to the next level of success.
