Pricing: ten FAQs

1. How do I know what to charge?
2. What should the relationship be between price and costs?
3. Should I charge more or less than my competitors?
4. What do I do if my competitor cuts his prices or starts a price war?
5. How can I increase prices without losing customers?
6. How can I predict the impact on sales of a higher or lower price?
7. Should I price one product low, as a loss leader?
8. Should I ever offer discounts or hold a sale?
9. What pricing tactics can I use for different times and different markets?
10. How often should I review my pricing?

1.  How do I know what to charge?

There is a "right" price for everything and it is well defined as "the maximum amount the customer is willing to pay for it". So how much are your target customers paying for alternatives to your product or service? 

The first step is to pull together a representative selection of competitive and comparable products or services and to prepare a list of all the features offered by each package. Few customers buy the product alone. People buy a package which includes supplier image, personal service, quality, flexibility, reputation, range of options, easy parking, technical advice and many other factors. A £3,000 used car from a single site garage could be worth £4,000 from a main dealer.

The next step is to make an objective comparison, using these features lists to help establish relative values to the customer. It is essential to be clear about what exactly you are selling, compared with your competitors. Then, finally, ask people from outside the company for their opinions of your working and conclusions.

This process inevitably takes time. But the impact on the bottom line, if you get it right, makes it worth every minute.

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2.  What should the relationship be between price and costs?

There is no relationship. Costs are facts and must be fully understood and managed. Prices are policy and have to be decided.

Customers know the value of what you are selling from their understanding of what is being offered elsewhere. You have to bolster the attractiveness of your offer with a clear presentation of features and benefits and set your price. If you have got it right, your price confirms the customer's evaluation and you may well make the sale. If your price is too high, the customer will get better value elsewhere. If your price is too low (as is often the case with smaller businesses), the customer may still buy elsewhere, for peace of mind.

If you generate huge gross margins, don't be embarrassed — you probably need the money to cover promotion and selling costs. If your gross margin is too small, you will have to either find a way of cutting costs or stop selling this product or service.

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3.  Should I charge more or less than my competitors?

The answer relates to three issues. What is your firm's image? What exactly are you selling? Who exactly are you selling to?

• Image

Pricing is a powerful communication medium. Your prices say a lot about quality, dependability, confidence and professionalism. Your prices must be in line with your firm's image.

• What exactly are you selling?

There is always a cheaper one down the road. But how does it compare with yours? You must include all the 'non-product' features in your consideration - technical advice, free parking outside, choice, delivery, availability, personal service, flexibility and reputation.

• Who are your target customers?

What is cheap to one person may be expensive to another. Once you are clear as to who your customers are, you will be able to create a whole package, including price, that is exactly right for them.

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4.  What do I do if my competitor cuts his prices or starts a price war?

It is essential to respond as quickly as you can, while using any means possible to avoid cutting your own prices. A cut of 10% may be a lot more than your business can afford. Ultimately, you may be unable to avoid price cutting, but you must consider other options. It is not uncommon for price cutters to find themselves in serious trouble so hold out as long as you can.

The first line of defence is to recognise that, although price is very important to a customer, it is most unusual for the purchase decision to be made on price alone. What are the other important factors? Convenience? Service? Choice? Dependability? Personal service? Promote them hard as added value.

The second line of defence is to give something away with your product or service. This will ideally be something that has a higher value to the customer than its cost to you, such as an extended warranty, free delivery, a supply of consumables, a service at half price, or the opportunity to buy three items for the price of two.

If the only sales appeal you have is low prices you could become fixed into a difficult situation. When prices hit rock bottom the only remaining element for you to whittle away at will be the quality of your offering. So it is better to find another way of attracting solid business, either by providing better service (the preferred option) or being more innovative in your marketing.

Price wars are usually selective. Supermarkets may reduce the price of sugar, but they will recoup it on other lines. Remington's Victor Kiam ("I liked the company so much I bought it") put his prices up when under threat and spent the extra profit on marketing. Success soon followed.

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5.  How can I increase prices without losing customers?

The appropriate answer to this depends upon the nature of your business. But there are several familiar scenarios.

1. Many businesses offer an excellent package, are unclear about who the target customers are, and charge low prices. A comparison of what is offered with competitors' offerings reveals that a price increase is justified. The increase is implemented. Some customers are lost - the ones that will be satisfied by a lesser package. But new customers are gained - the ones who demand supplier credibility and are willing and able to pay for it. In this situation, it is common to achieve a net gain in volume.
2. Raise prices gradually, to a plan. Increases may be applied to a few products at a time.
3. Raise prices and provide a substantial loyalty discount (with a time limit) for existing customers.
4. Change the package and relaunch it as a new product, at a higher price. New product, new package, new perceived added value.
5. Accompany your price increase with demonstrably improved marketing and selling professionalism.

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6.  How can I predict the impact on sales of a higher or lower price?

By experiment. But the trick is to control it carefully and minimise the risks.

The first step is to research your competitors and make an objective comparison between what they are offering and what your product or service offers. Use an item-by-item features breakdown of the package, covering specification, choice, quality, location, service and so on. Get the opinions of other knowledgeable people. As far as possible, remove the guesswork and try to eliminate your own bias.

Now you should know what order of price adjustment is required. The next step is a limited trial. Try it for a short time. Try it in a specific locality. Try it on a certain sort of customer. When a prospective customer declines, ask why and make a note of the answer. It may be nothing to do with price but be about something else which is not quite right.

Forecasting the impact on sales is always difficult, but should be done. Now forecast the impact of the price change on the bottom line and you will be in for a big surprise.

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7.  Should I price one product low, as a loss leader?

Sugar and flour have long been used as staple commodities to lure customers into supermarkets, in the hope that once there they will make more purchases. Used with care, loss leaders are a good way of getting noticed, particularly when targeting new customers. The hardest part of selling is to attract new customers into switching from existing suppliers without a good reason. Try to source a line at a special price for this sort of exercise, by getting the supplier to share the cut with you, in return for increased volume.

Also study the pricing policies of your competitors - these could provide useful clues as to how you can pitch your strengths against their weaknesses.

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8.  Should I ever offer discounts or hold a sale?

Discounts are a vital part of your pricing policy. They can help you to:

1. Differentiate between optional market segments (trade and consumer).
2. Encourage buyers to place bigger orders, or to place an order immediately ("This price holds good for only seven days").
3. Tempt buyers to buy a more profitable line ("10% off X, when you order Y").

If you are selling through intermediaries (agents or wholesalers), then discounts off the recommended retail price are the established pattern of trade. If you are in the confectionery trade, for example, it is called POR ("price off retail"): learn the jargon of your business sector.

Sales are used to clear old stock, to make way for new lines or to generate cash from slow lines. Cash in the bank is usually better than over-valued stock on the balance sheet or in the store room.

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9.  What pricing tactics can I use for different times and different markets?

Most tactics revolve around discounts and special offers, or "added value".

Added value: The usual ploy is to add into the package something special — a large number of options, an enhanced guarantee, delivery, service, credit, or special branding, packaging or presentation. In some markets, these devices are useful to hold prices up against fierce competition. In others, they can be used to justify higher prices than the competition.

Discounts and special offers are an effective way to stimulate business or to move stock quickly. It is important to have clear objectives, to qualify your offer and to promote hard. The discount should be for a limited period only. So should special offers, as they soon get tired.

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10.  How often should I review my pricing?

Most firms do an across-the-board price review every year. But there may be other, more urgent, occasions. The trigger could be:

1. A threat, such as the arrival of a new competitor.
2. A fresh opportunity, such as a change in legislation or technology.
3. The need to boost flagging sales (decline in the product life cycle).
4. Demand from an unexpected quarter (product featured on TV, or a fashion swing).

In practice, your pricing policy should be kept under constant review to take advantage of market opportunities and to make sure you make a sensible profit.

Competitors' pricing should be kept under continuous surveillance. In practice, this can all too easily be overlooked, as so many other issues fill the day. To stop this happening, it is prudent to establish a routine of gathering key indicators for regular formal review. This might be a monthly task, though emergency reviews should be held whenever serious competitive action changes the market situation.

A review is not a price change, of course. Every opportunity should be taken to avoid price erosion. Your review may conclude that a price reduction is unavoidable, but it is better to delay if at all possible and bridge the gap with new deals, special discounts or initiatives that add value to the package. One company cannot have a price war all on its own.

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