Free Shark Tank Jump Start Your Business: How to Launch and Grow a Business from Concept to Cash by Michael Parrish DuDell Page B
Authors: Michael Parrish DuDell
for $12. No matter how much you decide to shell out, you’re basically getting the same product: water,aqua, H20. So why does the cost vary so dramatically? Because each establishment has developed its own pricing strategy based on a detailed set of criteria.
Before you can decide how much you’ll charge for a product or service, you must take into account everything from market to consumer to competition. As with business models, there are many strategies to consider—more than twenty popular ones—but here are five of the most common pricing strategies you’ll encounter:
Cost-plus pricing: By far the most basic, cost-plus pricing combines the price of producing a product with the percentage of profit the company wishes to make. The result of that equation is the selling price. Let’s say, for instance, that your variable costs (materials, labor, production) come to $8 per unit while your fixed costs are $12 per unit, totaling $20 in cost. To make a steady profit, you want to operate at a 30 percent markup, so you add an additional $6 to the cost, which gives you a total selling price of $26.
Although this model may sound like the simplest way to ensure profitability, its simplicity can also be its downfall. The problem with cost-plus pricing is that it doesn’t take into account important factors like demand and competition. Without having more information about the market, it’s difficult to know if your product or service will be able to actively compete.
Value-based pricing: An effective choice for both product and service businesses, this strategy is based on the perception of value your product or service provides, not on any actual production costs. Take, for example, the eyewear industry. Whether you charge $50 or $500 for a pair of sunglasses, the production cost varies only slightly. You don’t pay $500 for a pair of sunglasses because the materials cost ten times asmuch. No, what you’re paying for is the perceived value of those sunglasses (e.g., the belief that you’ll look more fashionable). For this pricing strategy to be effective you must have an in-depth knowledge of your market.
Price skimming: Most business owners think that for profit to be high, the volume of sales must also be high. But that’s not always the case. Price skimming works the opposite way: relatively lower sales at a higher profit. A good example would be a boutique consulting firm. Instead of trying to secure ten clients at $10,000 an engagement, under this strategy the business owner would seek to gain four clients at a $25,000 price point.
Why would anyone want to adopt a strategy that assumes lower sales? Depending on your business, having fewer customers that spend more money might actually be a better solution. Not only do you create more exclusivity for your brand, the clientele you attract generally tends to become better customers. Of course, the danger with this strategy is that losing a handful of customers at the wrong time can greatly impact your organization. Still, it can be the ideal choice for certain types of businesses, especially service-based companies with premium offerings and deeply loyal consumers.
Penetration pricing: Sign up now and get twelve months of high-speed Internet service for only $29.99 a month. Sound familiar? That’s a perfect example of penetration pricing. Using this strategy, a business sets low initial rates in order to gain market share and then eventually raises prices. That promise of twelve months of cheap Internet usually comes with the caveat that you sign a two-year contract. And chances are, the second year will be billed at a significantly higher rate than the first. The key to using this pricing strategy effectively is to be transparent from the start. It’s not smart to hike up yourrates without warning your customers in advance. Remember what happened when Netflix did that?
“The price of anything is relative to the price of something else, which means you better
Before you can decide how much you’ll charge for a product or service, you must take into account everything from market to consumer to competition. As with business models, there are many strategies to consider—more than twenty popular ones—but here are five of the most common pricing strategies you’ll encounter:
Cost-plus pricing: By far the most basic, cost-plus pricing combines the price of producing a product with the percentage of profit the company wishes to make. The result of that equation is the selling price. Let’s say, for instance, that your variable costs (materials, labor, production) come to $8 per unit while your fixed costs are $12 per unit, totaling $20 in cost. To make a steady profit, you want to operate at a 30 percent markup, so you add an additional $6 to the cost, which gives you a total selling price of $26.
Although this model may sound like the simplest way to ensure profitability, its simplicity can also be its downfall. The problem with cost-plus pricing is that it doesn’t take into account important factors like demand and competition. Without having more information about the market, it’s difficult to know if your product or service will be able to actively compete.
Value-based pricing: An effective choice for both product and service businesses, this strategy is based on the perception of value your product or service provides, not on any actual production costs. Take, for example, the eyewear industry. Whether you charge $50 or $500 for a pair of sunglasses, the production cost varies only slightly. You don’t pay $500 for a pair of sunglasses because the materials cost ten times asmuch. No, what you’re paying for is the perceived value of those sunglasses (e.g., the belief that you’ll look more fashionable). For this pricing strategy to be effective you must have an in-depth knowledge of your market.
Price skimming: Most business owners think that for profit to be high, the volume of sales must also be high. But that’s not always the case. Price skimming works the opposite way: relatively lower sales at a higher profit. A good example would be a boutique consulting firm. Instead of trying to secure ten clients at $10,000 an engagement, under this strategy the business owner would seek to gain four clients at a $25,000 price point.
Why would anyone want to adopt a strategy that assumes lower sales? Depending on your business, having fewer customers that spend more money might actually be a better solution. Not only do you create more exclusivity for your brand, the clientele you attract generally tends to become better customers. Of course, the danger with this strategy is that losing a handful of customers at the wrong time can greatly impact your organization. Still, it can be the ideal choice for certain types of businesses, especially service-based companies with premium offerings and deeply loyal consumers.
Penetration pricing: Sign up now and get twelve months of high-speed Internet service for only $29.99 a month. Sound familiar? That’s a perfect example of penetration pricing. Using this strategy, a business sets low initial rates in order to gain market share and then eventually raises prices. That promise of twelve months of cheap Internet usually comes with the caveat that you sign a two-year contract. And chances are, the second year will be billed at a significantly higher rate than the first. The key to using this pricing strategy effectively is to be transparent from the start. It’s not smart to hike up yourrates without warning your customers in advance. Remember what happened when Netflix did that?
“The price of anything is relative to the price of something else, which means you better
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