Your pricing is right, when customers complain, but still buy

The pricing objective must be in sync with the overall business strategy

An astutely crafted pricing strategy is an essential requirement of any business striving to succeed in today’s market. Pricing is much more than merely adding a margin over the cost of production. It drives product awareness, demand generation and customer loyalty and it influences customer perceptions, impacts sales and mirrors the company’s attitude to transparency, fairness, and social responsibility. Finding the right balance between profitability and customer satisfaction is key to achieving sustainable success in any industry

Pricing a new product/service was one of the most challenging and trickiest tasks I had to perform, or participate in performing, in my senior corporate roles of Finance Director, Chief Executive Officer, Managing Director and Executive Board Director because when it came to pricing of a new product, service or offering, we faced a dilemma. Should we underprice to attract more customers, or should we overprice to maximise profits and portray an allure of superiority, or should we be strictly rational? Underpricing, and overpricing carry risks in terms of the company’s reputation, credibility, value proposition, social responsibility and overall success.Underpricing occurs when a company knowingly undervalues its products and services. Companies lacking confidence in the market’s acceptance of their new products and services deem it to be a low risk yet effective approach in attracting customers and clients. However, it may give birth to circumstances which are detrimental to business in the medium and long term. From a financial perspective, while underpricing may seem a good way of building sales volume, the foregone profits impede the ability to generate a margin which adequately contributes towards fixed costs, profit and expenditure on other strategic actions which may be necessary in countering the inevitable competitors’ reactions to the entry of a new product or service. 

A company notorious for habitual underpricing may find it difficult to raise prices because customers/clients who become accustomed to the ‘lower prices’ strategy of the subject company may not be willing to pay more. This can lead to the company being stuck with low prices which are inadequate to cover recurring and emerging costs. A prolonged continuation of this situation will result in the company not meeting its financial goals, not generating the necessary cash flow, not renewing its fixed assets, and ending in bankruptcy. 

From the perspective of marketing, underpricing can damage a company’s brand and reputation because its customers and clients may perceive the product or service to be of low quality leading to a muddying of the customers’ minds and a dilution of their loyalty. Further, underpricing tends to attract customers who are primarily bargain hunters. Bargain hunters are, usually, not loyal to the product/service and may not be willing to pay the higher price which circumstances may demand in the future.“Don’t fall into the irresponsible trap of setting low prices. It will kill your business cold. Low prices attract cheap customers with luxurious demands,” says Mac Duke, South Africa born marketing expert.

Overpricing, unless backed by product (refers to services also) features and utility values which are perceived as clearly superior to the products of competitors, can lead to a decrease in sales, initially, as customers look for cheaper alternatives. It can also damage a company’s reputation by making customers feel cheated and exploited, particularly when the product commands high market share and its demand is inelastic to price. Overpricing can, therefore, lead to a loss of reputation where customers may spread negative reviews and discourage others from doing business with the company because the company is engaged in society unfriendly practices. Furthermore, overpricing may lead to legal issues if a company is found to be engaging in price fixing via monopolistic and unfair trade practices or price gouging. 

Astutely crafted pricing strategy

An astutely crafted pricing strategy is an essential requirement of any business striving to succeed in today’s market. Pricing is much more than merely adding a margin over the cost of production. It drives product awareness, demand generation and customer loyalty and it influences customer perceptions, impacts sales and mirrors the company’s attitude to transparency, fairness, and social responsibility. Finding the right balance between profitability and customer satisfaction is key to achieving sustainable success in any industry. 

For a pricing strategy to be effective, it must consider factors such as market demand, competitive landscape, buyer power, customer value, brand positioning, marketing and distribution strategies, economic conditions, regulatory conditions and long-term business goals, et cetera. 

Pricing is not an inanimate one-off exercise. It is a dynamic process which evolves in line with economic forecasts, market conditions and customer expectations. A business must continuously monitor, review and update its pricing strategy to remain competitive and profitable.

A common mistake made by a company, and there are many who are guilty, is to believe that the pricing strategy of a business can operate in isolation of its overall business strategy and its marketing strategy. Adding to this woe is the belief of most leaders and managers that they have no control over pricing. They say it is dictated by the market and make the mistake of focusing on the outcome than the process. Instead of asking, “Have we considered all the factors which will determine the correct price?” they ask, “What should the price be?” The market does play a significant role. But there is so much that the business can do too. Pricing involves the activities and procedures that help in deciding the value, a company is going to charge in exchange for its product/service. It is a process of determining the price which is optimal for both the manufacturer and the customers. 

Studies reveal that a successful pricing process must have, in the minimum, two basic features. Firstly, it must fit snugly into the overall business strategy and secondly it must complement the marketing strategy.

Before establishing a pricing strategy, the business must be clear about what the strategy needs to accomplish and must ensure that teams are aligned. Is it the objective to maximise profits? Or is it to gain market share? Or is it to build the brand or just get through some tough times? The pricing objective must be in sync with the overall business strategy.

Many participants in the pricing process

Typically, there are many participants in the pricing process, these being Sales and Marketing function which communicates what customers want, the Production function which confirms its ability to manufacture and supply the product at a competitive cost, the Distribution and Logistics function which proposes the best way of getting the product to the customer, the Finance and Accounting function which determines the cost of production and confirms that the product meets the criteria which enables the achievement of the financial goals, the Strategy and Planning function which works out different profitability scenarios through various combinations of price, volume, marketing/selling expenditure and other expenses, the Legal function which confirms the compliance of the pricing, marketing and sales strategies with prevailing laws and regulations and the Communications function which compiles the right messaging, et cetera. 

Given the natural tendency of these functions to operate as silos within a company, it is imperative that they be bound by a commonality of purpose, goals, and objectives through a well communicated and tightly coordinated overall strategy. The goal is to ensure that the chosen pricing strategy is appropriate for the product, will be well received by customers, can be executed by staff, and will lead to achieving the overall company objectives.

The marketing strategy and pricing strategy enjoy a symbiotic relationship. As alluded to earlier, the marketing strategy complements the pricing strategy by enhancing the product’s appeal to the target audience, > by determining the demographics of the target audience, including their age, gender, location, likes, dislikes, and values, > by linking the value the customer perceives in the product/service to price through a value analysis, > by incorporating the customer needs into the design of the product, and > by evaluating the alternative sustainable pricing strategies from a basket of price skimming, dynamic pricing, competitive pricing, premium pricing, loss leader pricing, multiple pricing, bundling et cetera. For example, premium brands like Apple often follow a strategy of price skimming where the products are initially priced very high with higher profits so that fewer sales are needed to break even. After a period of managed skimming, it usually lowers its price to bring it in line with the competing pack, a trend not lost in the minds of Apple’s competitors too.

Marketing and Sales must learn everything they can about the current and potential customers. What do the customers think about the business’s products or services? What problems do the products/services solve for them? Are there non-customers experiencing the same problems? How do they cope with such problems? How eager or hesitant are the business’s target customers in finding a better solution or trying something new? What is more important to them, solution, or price? Where do prices fall on their priority lists? How big is the total market? What factors could grow or shrink the market?

The essentiality of knowing the customer, the competitors, the industry, and the key factors influencing the industry is unarguable. Sadly, I have found that many corporates in Sri Lanka are not very thorough and detailed in assessing their competitive positions and in evaluating their current and emerging competitors when they develop long, medium- and short-term business plans. Neither are they intense in understanding the industry structure and the industry behaviour. The Porters Five Force Model comprising of the five components of competitor rivalry, supplier bargaining power, buyer bargaining power, threat of new entrants and threat of substitutes which I use quite religiously in strategy formulation is also a useful tool in arriving at the determinants of a pricing strategy.

Like a game of chess

The pricing strategy is like a game of chess with the company and affected parties making moves and counter moves. Understanding the level of competitor rivalry is a vital first step in assessing a company’s pricing power and in making data backed decisions. In an industry with multiple participants vying for market share the rivalry is like a tug-of-war with ‘no quarter given and no quarter asked.’ On the contrary, in a niche market, where the rivalry is usually limited, the company has more control and therefore enjoys a greater proportion of predictability over pricing.

In an industry where there are just a few powerful suppliers dictating terms and conditions on input prices, the company’s flexibility on the pricing of its own products will be significantly lower than when there is a multiplicity of suppliers of key inputs. When there are multiple suppliers competing for the company’s business, the company will have an upper hand, enabling it to negotiate better input prices and, as a result, offer competitive pricing to its customers. Like what applies in the situation of a few powerful suppliers, if an industry is dominated by a few powerful buyers, the pricing power of the company is significantly eroded. Where the company’s customer base is diverse and widely distributed the company will have more control over its pricing strategy. A deep understanding of the power of buyers will enable the company to craft its pricing strategy in optimising its profitability by providing value that is appreciated by its customers.

Where the company operates in an industry which has high barriers to entry by way of significant capital expenditure, patent protected products, wide distribution networks established over long periods of time and/or complex regulations, its pricing power is more defendable. However, if the barriers of entry are low there is the danger of the advent of fresh players who may disrupt the market and disturb the supply/demand equilibrium with market share seeking underpricing. This will invariably challenge the company’s power of pricing. The existence and/or emergence of alternatives, and substitutes, to its products is another factor which can exert pressure on a company’s pricing strategy. As a safeguard against this, it is important that the company continuously innovates, and value adds in preserving the uniqueness of its products. 

From small and medium sized enterprises to large corporations and from sole proprietorships to global conglomerates and every kind of company in between, one of the most challenging questions, fundamental as it may be, which businesses face is, “how much should we charge for our products and services?” Adhering to a disciplined pricing process, where goals are clarified, data is carefully analysed, and appropriate methods are selected helps increase predictability, reduce uncertainty, avoid pure ‘gut feel’ decisions and improve outcomes, being outcomes which enable a larger market share and higher profits and facilitate business sustainability.

Whilst the Porters Five Force model will help to assess the industry’s competitiveness, a thorough understanding of its own business is a critical prerequisite in a company’s pricing process. It must dig deep in identifying its strengths and weaknesses and most importantly its limiting factors. The intimate knowledge of its cost drivers, its fixed and variable costs, break-even volumes at various price points, capacity utilisation, and production efficiency are essential information. Boart Zambia, a subsidiary of Anglo-American Corporation Limited, and a large manufacturer and supplier of drilling accessories to the entirety of Zambia’s copper mines had a standard practice of keeping close tabs on the utilised and free production capacity of competitors as an act of preparedness in the event of a price war. The manufacturing and service subsidiaries of John Keells Holdings PLC also followed similar practices by being well informed of the capacity, capacity utilisation and cost structures of competitors in the various industry sectors it operated in. Beware! – A price war may attract customers, but it can also create financial pain for all involved. Price wars, if not astutely thought through, can negatively affect profits and hurt a company in the medium to long term.

Prime position to develop pricing strategy

Once the business has assessed its own capabilities and compared them with its competitors’ strengths and weaknesses and other alternatives, it will be in prime position to develop its pricing strategy. Underpricing a close competitor can sometimes be a huge advantage, as long as ‘what if’ scenarios and action plans have been developed. Cutting the margin by say 10% may double sales and may prove to be worthwhile. In this respect, the elasticity of demand is an aspect which must be considered. For products with high elastic demand, it is possible that the business could make more money by lowering the price, because the increase in sales volumes would more than make up for lost margin per sale. But raising prices could be a better move for a product with high inelastic demand, because, in addition to making more money per sale, about the same number of units will be sold.

In conclusion, ‘Pricing’ is a process. It is not an intuitive ‘pluck’ off the air. It is not dictated by the market alone but by several other factors within the control of the company. Pricing decisions are the culmination of a long process of research and analysis. The good news is that it can be forgiving. If the business misses the right price in the first instance, it can usually change it subsequently. Much can be learned along the way, and the best companies continuously incorporate such learnings into their process. Pricing therefore need not be a conundrum.

John Harrison, the inventor of the marine chronometer, summed ‘Pricing’ aptly by stating, “You know you’re priced right when your customers complain—but buy anyway.” 

(The writer is currently, a Leadership Coach, Mentor and Consultant and boasts over 50+ years of experience in very senior positions in the corporate world – local and overseas. www.ronniepeiris.com.)