For everyone, we have definitely encountered times when we need to sell anything, be it selling our products or services for a business, or selling our own personal items. How do we price the products, services or even our very own personal items we sell? I have always held the opinion that it is never good to compete to sell anything based on prices alone. Even if an item is a commodity which does not differentiate itself from another same commodity being sold by a competitor, one can still adopt a creative selling approach to make the item of commodity become unique in the eyes of the buyer. This involves creating added value to the buyer so that he will not be just buying the same item which he can easily buy elsewhere from another competitor. It does not take much thinking to appreciate that the same Coca Cola can drink can be sold at different prices at different venues. A can of coke sold off the shelf of a supermarket in Singapore costs approximately $0.70. The same coke sold off a vending machine costs approximately $1.20 while the price of this same coke sold in a restaurant costs approximately $2.80.
Why is there such a disparity in the prices of the same item, a can of coke? I consider this creative selling which involves creating added value. The same coke sold off vending machines bring convenience to the buyers as they can go to any nearby machine to buy a can of coke at anytime of the day including wee hours when everyone is sleeping when a particular buyer has a sudden craving for this soda. A restaurant offers a comfortable dinning environment to enjoy this can of coke. So, the price of coke is sold higher for the consumer not only to drink coke, but also to drink it at a very comfortable environment. This creation of unique added value makes the selling of coke becomes uniquely different commanding different selling prices. For the vending machine, it targets consumers who want the added value of convenience. For the restaurant, it targets consumers who wants the added value of comfort to enjoy this soda.
Well, do people still pay much higher prices for a can of coke sold off a vending machine or in a restaurant? Your guess is as much as mine. Yes. People do pay for higher prices. The difference is that coke sold in a restaurant only attracts a certain target consumer group, those going for added value of comfort while vending machines attract another group of consumers, those going for convenience. As to coke sold off the supermarket, it does attract peope who are price sensitive and do not need any added value to their purchase of the coke (placing their only buying consideration on price alone and nothing else that can move their hearts to pay more). Thus, by focusing on the creation of value even when selling the same item, higher selling prices can be commanded and the product or service can be sold to a relevant target group of consumers who see the added value they are paying more for.
There are 5 different ways by which most businesses priced their products namely:
1. Making wild guesses.
2. Following industry norm.
3. Clients dictate their prices.
4. Cost plus pricing.
5. Target return pricing.
1. Making wild guesses
This needs no explaining. The seller prices his products and services according to what he thinks buyers are willing to pay. There is no survey and research done. Neither is there any history to base the pricing on. The pricing is based on luck mentality. If the product can sell at this price, it sells. Otherwise, it will not.
2. Following industry norm
This way of pricing looks into what prices the other competitors are selling the same or comparable product or service. Usually, an average selling price in the middle is derived by considering the highest price and lowest price other competitors are selling comparable products or services. This works on the assumption that other competitors in the industry must be doing the right thing since they are able to sell their products and services.
However, assumptions may not always be a good thing. What is applicable for other competitors may not be applicable for oneself as their situation is uniquely different from each other as well as different from oneself. For example, a larger competitor may be able to sell their products or services at lower prices based on their economies of scale without eroding their profit margin. A weaker competitor may find it hard to follow suit with low pricing as this will mean a much lower profit margin or even making a loss resulting in the inability to sustain itself. In the long term, even if the weaker competitor is able to barely survive, there will be very slow growth (if any) as without profits, growth will slow down. Thus, a pricing which works for a competitor may not necessarily work for oneself.
3. Clients dictate their prices.
This way of pricing places priority in the clients to dictate what maximum prices they are willing to accept to buy one's products or services. This is done by running surveys, focus group discussions or causal talks with clients to know what maximum prices they are only willing to accept when buying one's products or services. It is good to always listen to the needs of one's clients. However, if one decides on the selling price solely on the clients' wish, it may mean lower profit margin thus resulting in unsustainability or lethargic growth in a business.
A business exists to serve the needs of its clients. However, also as important is the need to be profitable so as to continue in existence to serve the needs of its clients and even serve it better. If a business is not making profits, how can it grow and improve its products and services to continue serving its clients with better products and services. So, profitability of a business and its great meaning and purpose to serve through providing relevant products and services to clients go hand in hand. Greater value offering comes at higher prices. Higher prices fuel profitability to further improve value offering.
By not allowing clients to solely dictate the selling price, one is also training its clients not to focus on price alone but consider the value in the product and service offering of a business.
4. Cost plus pricing
This way of pricing considers the cost of producing a product or service, and the selling price is derived by adding a desired amount of return based on cost. This way of pricing has some inherent flaws. By using this way of pricing, one is not considering whether the clients can accept the selling price. Clients generally do not care about how much it cost to produce one's products or services and also the amount of desired return one requires when pricing the product or service. What they generally do care is whether they need or want the product or service and whether they want to pay or can afford to pay at a particular selling price.
In this way of pricing, one may also need to carefully consider the true cost of producing a product or service. Sometimes, it may suddenly require a large increase in cost to acquire a machine or more manpower cost and delivery cost to sell products or services to the clients. Thus, costs do fluctuate significantly sometimes. Also, there may be seasonal demand for one's products or services. Is a business going to sell at a much significant lower price when the cost of producing a product or service has gone down due to slower demand for some periods of the year? Can one really fix a suitable selling price based on cost plus way of pricing?
Furthermore, pricing of a particular product or service may influence sales of other different product lines or service lines in a business. If pricing a product A at a certain price results in more of the product sold and less of another product B being sold, the loss incurred on product B has to be amortized and accounted for as a cost added to product A. Thus, there will be changes to costs of individual product or service lines.
Also, there may be differential costs in selling the same product through different people or different means. For example, it may cost more to deliver the same product overseas than locally. It may also involve different costs to sell the same product by different salespersons.
Thus, this way of cost plus pricing is a difficult way to determine the selling price of a product or service as one will need to know the actual true cost of producing the product or service.
5. Target return
What is the purpose of pricing? 
This way of pricing looks at a business and its prices as an investment. A target return on the capital invested in a venture is set. This is one's required return on investment. This way of pricing is more focused on profits, but it can also ignore the realities of the market similar to cost plus pricing, by focusing on unrealistic return on investment.
What is the purpose of pricing?
As one can see, no matter which way of pricing one chooses, the purpose of pricing is still to make profits for a business to ensure growth and sustainability. Even if one is taking a loss by lowering prices for example in giving discounts, it must still serve the purpose of taking a loss today in order to make a greater profit tomorrow.
Price skimming
One way of ensuring high pricing is to adopt a price skimming method. The objective of price skimming is to serve clients who are not price sensitive and are willing to pay higher prices for the exclusive value they can get from one's products or services. This is similar to the analogy of skimming off the top cream of the milk much like skimming off the top level of clients who are willing to pay higher prices for the exclusive value they get. This ensures high profit margins.
Sequential skimming
Another method related to price skimming is sequential skimming. For this method, clients who are willing to pay higher prices for premium value they get from a product or service is secured first. When demand for the product or service drops, the price of the product is lowered to increase demand for the product serving the next level of buyers. The price is again lowered when demand further drops after sometime thus attracting the next lower level of buyers. This method of sequential skimming is evidently seen in the sale of many electronics such as computers. When a new computer product is newly introduced in the market, it is priced at a premium attracting the first level of buyers who are not price sensitive but are focused on the immediate value they get from their purchase. When demand drops, the selling price is decreased to attract the next level of buyers and so on.
Penetration pricing
This method of pricing involve lowering prices below the competitors to quickly attract more clients thus seeking to increase market share. Penetration method works on the assumption that people are always attracted by lower prices. This method may be useful to increase market share quickly, but it can also become damaging to profit margins. Thus, this method is a short-lived method to penetrate one's market to gain market share and should be carefully used. In order to sustain long term growth and profitability, other methods of pricing such as skimming are better. One should not only consider the market share for his products or services, but more importantly the profits. For without profits, a business cannot sustain itself.
Conclusion
Pricing of product or service is an important part of a business. Purpose of pricing is to make profits without which a business can not sustain itself or see long term growth. There will always be people who are not price sensitive and willing to pay premium prices for premium value they can get from their purchase. This requires the business to adopt creative ways of offering premium value in their products or services in order to charge higher prices to attract their top level buyers. Sequential skimming is a method which can help to maximise the prices at each levels one can sell sequentially to different levels of buyers. Profits should be also considered in addition to gaining market share when using price penetration. For what good is there in gaining market share when a business is selling products or services at low prices which does not sustain profitability and results in causing long term irreparable damage and loss to the business.
Pricing is an important part of a business. The purpose of pricing is to make profits which results in long term growth and sustainability of a business.
Posts
