Pricing your products and or services for success

Every company has to put a price on what it sells although most companies often fail at this important task in a manner that jeopardises long term value.

In the advent of big data in relation to consumers, companies now have the ability to create tailored marketing solutions and adjust prices to fit people’s budgets and preferences.

Though some have succeeded in driving profits and expanding their market share as a result, many have not. Let us look at price optimization as a simple tool for a great pricing strategy.

Why price optimisation?

The benefits of price optimisation stem from a company’s ability to understand and take advantage of either of two variations:

Price Elasticity Variations:  Simply put it is sensitivity of the demand of your product offering to changes in pricing. Similarly it is the volume effect of a price change on a company’s customers is typically heterogeneous.  For example, in Africa today people can access internet and make price comparison for virtually any product or service leading to fierce price competition in some markets leading to higher price elasticity.

Take an example of a typical entrepreneur selling a bag of rice, a slight increase in his/her price would lead to low sales due to the existence of intense completion both locally and internationally and also availability of substitute products such as maize. Compare this to a luxury car dealer whose demand for cars is not very much affected by slight increase in price.

This heterogeneity in elasticity leads to significantly different strategies for setting prices optimally for different companies in the various sectors. Companies would therefore need to be very careful to ensure that the integrity of the consumer proposition is not undermined by apparently unjustifiable price variations.

 
Margin Variations:  Margins can vary to a similar degree to price elasticities.

Those customers with low margins and low price elasticities are prime candidates for price increases.  On the other hand those with high margins and high price elasticities should be considered for price reductions.

Companies need to know where all their customers sit in terms of margins.

Price optimization thus allows a company to segment its customers and appreciate that it has groups sitting on very different places on that same curve and therefore give an appropriate price.

How to use price optimisation

When setting prices, a company must reflect on its consumers, competitors, product and customer economics, and broader strategy.  Companies need to ask the following key questions before pricing its product offering or value proposition;

• How sensitive is the consumer to the price of the product or service?
• How does your price proposition compare to that of the competition?
• How well do you understand the economics of your product and customers?

• Is the pricing coherent and aligned with the company’s competitive, product and consumer strategies?

The long, but typically profitable, journey to adopt a price optimisation strategy that is right for your company starts with a few important steps. To define the optimal price structure and pricing levels, a company must have:

• An empirical understanding of how price changes affect volume in aggregate and by customer segment
• An understanding of the marginal profitability of its customers (on a multi-product and multi-year basis) and how customer characteristics drive variations therein
• Scenarios for how consumers and competitors might react to price changes
• Well-articulated consumer, competitor and product price strategies — which should be aligned with a coherent pricing plan
• A model, however basic, that demonstrates the trade-off between the volume and value impacts of price changes

Then, the company should be sure that it adheres to these five precepts.

1. Don’t leave it purely to the pricing team. Given that the effects of price changes go beyond the pricing or marketing teams, it is essential that any price optimisation work have broad engagement and support throughout the company.
2. Set a challenging target for the benefits delivered. The benefits achievable from price optimisation can be surprisingly large.
3. Audit your current performance. Companies should identify the areas in which the greatest opportunities for improvement lie through asking those same four questions.  They will help you establish where the opportunities for improvement may lie.
4. Identify barriers early. It is essential that firms assess those that most apply to their organisations and systematically mitigate their impact.
5. Start simple. The simultaneous introduction of multiple factors into a company’s pricing structure would be unwise. Not only is it difficult to collect the necessary statistics, but coincidental changes are hard to measure and also result in greater risk.