We are still talking on the subject of preparing the business plan and today we briefly review on the second part of the Marketing Mix – ‘pricing’.
The pricing strategy portion of the business plan involves determining how you will price your product or service. The price you charge has to be competitive but still allow you to make a reasonable profit. The keyword here is ‘reasonable. You can charge any price you want to but for every product or service there’s a limit to how much the consumer is willing to pay.
Your pricing strategy needs to take this consumer threshold into account. The most common question small business people have about the pricing strategy section of the business plan is, “How do we know what price to charge?”
Several pricing strategies exist for products and services and choosing the best for your business depends greatly upon your overall long-term business strategy.
Competition-based pricing strategies focus solely on what the competition is charging and strive to meet or beat those prices. Sometimes this strategy is referred to as a low price leader strategy. The goal is to best your biggest competitors based on pricing alone. This pricing strategy is a difficult one for small businesses to maintain, because it provides very narrow profit margins that make it challenging for the small business to achieve enough momentum to grow.
A penetration pricing strategy is used as a loyalty-building or market-entry tool. The penetration pricing strategy offers a high-quality product at a much lower than expected price. This combination helps the business enter a new market even when strong competitors exist and it builds loyalty with new customers from the beginning.
Also known as a promotional pricing strategy, the goal of the loss leader pricing strategy is to get new customers even if you do not make a profit from the initial sale. By taking a loss on the first sale, businesses can offer related products or upsells at normal prices. Despite losing profits on the promotional product or loss leader, enough profits are normally made from the additional regular-priced products and services to sustain the strategy for the long term.
Premium pricing takes advantage of a segment of consumers who believe high quality comes at a premium price. Instead of trying to have the lowest price amongst competitors, businesses who use the premium pricing strategy attempt to price their products and services at the highest in their market. This strategy limits the customer base available to market products and services to but also provides much higher profit margins for each sale.
An appropriate pricing strategy will depend on how you want to position your product or service. You may want to charge different prices for different customers. For instance, one-off sales generally carry significantly higher costs than repeat business, so customers who purchase regularly, or buy add-on or related products, are more valuable. Customers who are always demanding special features or service are expensive to satisfy and will be less profitable, unless you can charge them higher prices to justify the time and effort involved.
A cost-plus approach to pricing is a useful and necessary starting point to ensure you aren’t undercharging for your product or service. It simply involves calculating all your production/sales costs in and then adding the amount you need to make a profit. The trick is to include all of your costs so get your calculations checked by your accountant.
Although cost-plus pricing can’t definitely determine what your prices should be, it will tell you whether the prices are viable. If you charge less than your variable costs (the direct cost of making a sale), you will make a significant loss. If you charge more than your direct costs, each sale will make a contribution towards covering your fixed costs (also known as business overheads) and ultimately towards making a profit.
The disadvantage of the cost-plus approach is that it doesn’t take into account three important factors: The level of demand, what competitors charge and market expectations (what customers expect to pay). You’ll need to consider these three issues before making your final pricing decisions.
Benchmarking your costs
Reviewing changes in your costs is always important. Varying your prices can increase your profitability. Some typical tactics include: (1) charging lower prices for high-profile products to capture customers who will also buy higher margin products – this is usually called a loss leader, (2) charging different prices at different times of the day, week or year to reflect changing demand or the changing value to customers of your product, (3) charging different prices for different levels of service or product specification.
Discounting can be worthwhile in certain circumstances but only if it achieves your aims. For instance, clearance discounts can help you to sell off old stock, release working capital and improve your cash flow. Introductory discounts can encourage customers to try a new product but they may create the wrong image for your product or generate sales that are not repeated when the discount is removed. These discounts can also cause resentment among current customers.
Review your prices regularly to ensure they are optimal and that you’re keeping up with trends in your industry and the overall market. Any changes in turnover can signal a pricing problem or an opportunity. For example, if you sell products with high or growing market share, this may give you an opportunity to increase prices.
If you’re a service business and sell your time, then getting in more business than you can deal with may be a signal to increase your pricing. Similarly, if you pitch or tender for business, too high a success rate suggests you’re underpricing. If both your margins and market share are low, you need to change something – or consider discontinuing the product.
Increasing your prices
When considering a price change, analyse the potential impact on your profit: What will the effect be on sales volumes? What will the effect be on profit margins? Increasing prices and therefore margins, can sharply increase your profits, even if your turnover drops.
Always explain to your customers why you’re increasing prices and give them fair warning, especially if they need to budget for the increase. Use the price change as an opportunity to re-emphasize the benefits you offer, such as: you’re improving the specification or quality of the products or you are introducing new, higher priced products with more benefits.
Good relationships with your customers can help to improve their perception of the value of your product and the risk of them trying alternatives. On the other hand, trying to hide price increases runs the risk of adverse reactions when customers realize what you’re doing.
Underpricing your product can be even more dangerous than overcharging. Remember that while prices are low, so too are your margins. It’s far easier to reduce prices than to increase them, so if in doubt, try higher prices first. You may discover that your target market is not particularly price sensitive.
Planning guidelines for business plan
Examine the history of price strategies for each market segment and describe the impact on the product’s market position. Indicate the pricing trends as they pertain to new product features, expected market changes, trade and consumer reactions and competitive responses to your pricing strategies.
(Lionel Wijesiri, a corporate director with over 25 years’ senior managerial experience, can be contacted at email@example.com)