Pricing – science or art ?
In this first of two posts I’ll discuss how setting the price of your product or service is a keystone of your business plan.
Any business addresses the question……. “What am I selling, who will buy it, and how much will they pay?
The top item on your Income Statement / Profit & Loss Account is “Revenue” ….. now Revenue is defined as units sold multiplied by price per unit. So the importance of getting it right is evident.
Way back in time, as an apprentice accountant for the tractor firm Massey-Ferguson, I had a spell working in the parts pricing department with responsibility to develop a new pricing package for all spare parts in one of our European markets.
It was a huge package of parts….
If you think about how many parts you can imagine on a tractor… from full engines to individual bolts and cables … well it amounted to hundreds of individual part numbers to add into the parts catalogue with a price.
I was learning on the job and I was surrounded by an incredibly knowledgable and experienced team. I was walking the tightrope (as I had to deliver my justified price list to the European Marketing Director) but I had a robust safety-net in my team.
During this time I learnt the magic of pricing. Being show both the science and the art of maximising Revenue through setting and fine-tuning piece prices, package prices and loss-leaders.
More recently I have been coaching and mentoring early-stage businesses in business planning and financial modelling. A key discussion is always about the price they should or could be charging versus what they think they “can get away with”.
There it is! Right there!
The doubt about their offering and what price they feel they can charge for it.
Well, OK. Let me help you through that process.
Pricing is both Science AND Art.
The Science revolves around the push and pull of your financial plans.
- How many units do you think you will sell? And at what price point?
- How much revenue do you need to generate to meet your EBITDA / Net Profit goals ?
- What are your cost of sales per unit?
- What is your unit contribution ? The amount to which your sales are contributing to cover your overheads.
The Art lies with:
- How much are your closest competitors charging ?
- Are you competing purely on price, or do you have a differentiated product or service ?
- If differentiated – what value will your customer pay over your competitor’s pricing ?
- Do you have a strategy for your product that includes changing pricing at different times ?
- Do you have a range of products or services to consider and price in relation to one another, or as a package ?
- Are there product alternatives that your customers might compare your pricing with ?
As explained above, pricing is first and foremost a marketing activity…. one of the “4-P’s” – Product, Price, Place and Promotion. In order to safely play in the Marketing art space you need a firm handle on the science part.
My pricing exercise at Massey-Ferguson played out like this:
- I proposed prices compared with the similar package being sold in a neighbouring country. This gave a healthy margin on a package of expected sales in the region. All good ?
- Wrong !
- The Marketing Director explained local market conditions and suggested a package of MUCH lower prices.
- To the astonishment of my team I spoke directly to the Director, who was calling from in-country, and explained that those levels would provide almost no contribution and we needed a minimum margin to be viable.
- Boom ! Apprentices aren’t supposed to have those conversations!!
- The Director laughed, acknowledged that I was following the policy line and we agreed a package that had certain loss-leader products but healthier, compensating, margins in others.
The Science and Art of Pricing in action !
In the next post I’ll explore some pricing strategies and tactics to apply to your situation.