Pricing In Business

Pricing is 25% of marketing strategy - yet most business owners view pricing as a simple, tactical decision.  The  most commonly used pricing model is "Cost Plus" (since my labor cost is $15 per hour - I'll charge the customer $30 per hour)

Fortunately, entrepreneurial-minded business owners can take advantage of their competitor's weakness by putting aside the "Cost Plus" pricing model and adapting the superior "Price Minus" model.  Keep in mind that the "Price Minus" model may also require adapting your existing business offering to be better aligned with customer demand.  The best way to illustrate the "Price Minus" model is through an example:

The founder of IKEA may be the wealthiest man in the world (nobody knows for sure since his largest asset is privately held).  IKEA embodies the "Price Minus" strategy.  Let's examine how IKEA decides to produce a desk for college-bound students.  First, they determine the demand for a desk containing ONLY certain important characteristics (e.g. comfortable, accommodates a laptop) and decide how much people will pay (detail on this to come).  Say they figure $135.  Second, they subtract the amount of profit they need...say $13.50.  Simple math means they have $121.50 ( $135 - 13.50) to build the desk. Ultimately, IKEA's target market (college kids in this case)  will do some searching around for a desk and they find just what they want at IKEA for $135.  But what about IKEA's competitors?  Target has an oak desk for $195 - too expensive.  Pier 1 has a desk for $130 - a stylish one - but without the comfortable, plastic chair that college kids "must have".  

Now that you see the power behind the "Price Minus" model, let's apply a three-step process to pricing any product or service:

1) Identify the Competitive Range of existing prices for all substitutes and alternatives to your business offering.  Example: Southwest Airlines identified that its competitor (at the high-end of the range) North West Airlines charged $450 for a ticket from Minneapolis to Phoenix, while Budget Rental Car (at the low-end) charged $110 to rent a car for the same trip.

2) Estimate your price within the Competitive Range according to the level of difficulty for competitors to "copy" your new pricing strategy.  If your product or service can quickly be duplicated by your competitors you will need to price at the low end of your selected range (about $110 in our Southwest Airlines example) to achieve a first mover advantage.  If your business has the benefit of high barriers to entry (e.g. patents, exclusive licenses) you can price closer to the high end of the Competitive Range (about $450).

3) Launch the new, efficiently-priced product or service.  After determining a price and subtracting the profit your business requires, the remainder is cost.  That cost figure drives the good or service your business produces.  If your good or service cannot be produced at that cost its time to strip out unneeded features.  In the case of Southwest Airlines, the company may have determined that serving peanuts instead of turkey sandwiches is an acceptable cost cut (and what customer would insist on the turkey sandwich if they realized the ticket cost builds in an extra $38).  I implore you...find those turkey sandwiches in your business and stop serving them to your customers!  The other possibility that exists for many businesses is forming an alliance with another entity that allows you to tap its competitive advantage (and superior cost structure).

This post is focused on Pricing strategy, which necessarily requires discussion of Product strategy.  The two go hand in hand.  Product (or service) research allows you to identify the features customer really care about.  Execute the "must haves" flawlessly and forget the rest.  This allows your company to create a unique value proposition that is priced right and most importantly....makes the competition irrelevant.