There’s a right and a wrong pricing strategy
Price is an important factor in the consumer decision-making process. Businesses must have a solid pricing strategy—and that does not necessarily mean continually lowering prices to beat out competitors.
Simply lowering prices, without a shift in perception among consumers, will not yield worthwhile results, and by employing the wrong pricing strategy, businesses stand to lose not only customers and potential customers, but they may be unnecessarily compressing their own margins.
A professional price analysis is an endeavor to determine the optimal price of a product based on various factors. Because when these factors are broad and complex, it is essential that an expert perform the analysis to determine which factors are significant and their respective weights in the outcome.
But, oftentimes even the largest finance teams find it difficult to prioritize projects like this and smaller organizations don’t have a great enough need to bring on a financial analyst full time.
Why and when is a pricing analysis critical?
As noted above, price is an important factor in the decision making process. Whether a direct factor or playing an integral role in several other psychological factors, a business must correctly price its products. But methods to determine the price are more complex than simply looking at competitors’ prices. Costs of manufacturing, target market, customer purchasing power, customer loyalty and preferences, type of product (luxury, commodity), and others are influential aspects.
Businesses that are losing ground to competitors may benefit from a pricing analysis, as there may be latent variables that go unconsidered by management. Especially for small businesses with only a few employees, perhaps none of which have a background in marketing or finance, it is easy to overlook some of these factors.
Businesses that are interested in entering a new market will likely need an analysis too. Having someone with experience in that market is indispensably helpful. And businesses that are planning major changes to existing products may want to consider an analysis to determine if they should raise, lower, or maintain their price points.
Businesses that are struggling with razor-thin margins or even losses can benefit from pricing analyses. Adding 10% to the price may seem anathema for a business that is struggling, but perhaps the extra cost to consumers, coupled with a smart, differentiating marketing campaign, could lift the business out of hardship. After all, not all companies compete solely on price.
Why do some businesses forego an analysis?
Sometimes markets may be straightforward, and choosing a pricing strategy is relatively simple. Unfortunately, this is not usually the case. So why do some businesses choose to forego an analysis on something as complex and vital as pricing strategies?
Often small and medium sized businesses are focused on bringing the best product to market or providing stellar customer service, and they simply do not have time to perform a thorough analysis. In these cases, the staff may even realize how important to analysis is, but they do not have the time or manpower to analyze price. Other projects take priority, so the pricing analysis is continually delayed and years go by without the company ever developing and implementing a solid, data-based pricing strategy.
Other times there is simply no one in the company that feels competent enough to perform a full analysis, so they employ heuristics on-the-fly and move on. The use of heuristics, though, can easily cause important factors to be masked and lead to less-than-expected performance. It may also lead to less-than-potential income, where income or customers are not captured due mispricing.
The consequences of foregoing an analysis
The most threatening consequence of foregoing an analysis is the loss of customers to competitors with a stronger pricing position. Businesses exist solely because customers buy their products, but if a competitor is outpricing them, the business will continue to struggle in the future.
Outpricing is not necessarily undercutting, either. Undercutting competitors may be counterproductive, especially if that technique eradicates margins, and those lower margins force the company to compromise on customer service or product quality. Moreover, if the competitor follows suit and subsequently lowers price, even if it is not substantial, the perception of a lower price from the competitor may be enough to retain customers for that competitor, essentially compressing margins for the original business without any positive result in customer retention or acquisition.
On the other end of the spectrum, the wrong price may be a source of customer dissatisfaction. High prices tend to correlate with high quality, so if customers feel they have received subpar service or goods for the price they paid, they may not remain customers long. Determining how customers perceive and feel about a price requires in-depth analysis of the market and customer interaction.
Of course, one further consequence is lost: opportunity. By pricing too low, a business may be leaving money on the table. This money could be used for R&D, better employee salaries, better customer service, or to expand the business without relying on outside financing.
It may not be possible (or even wise) to hire someone full time for pricing analysis. A small business that isn’t ready to expand may want to keep its circle of employees small, too. Price analysis outsourcing, such as through Paro, is an excellent compromise: the business can develop a competent pricing strategy, but there is no permanent addition to payroll.
For businesses that are not constantly introducing new products or entering new markets, a single analysis may be sufficient to develop a proper pricing method for the foreseeable future. Once the business starts to expand or an influential factor changes (like cost structure or the target market), the company can simply request another analysis, again without a permanent addition to payroll costs. Once the company is large enough to employ its own analysts, it can employ one full-time – or it can continue to outsource if it finds the relationship mutually beneficial.