Pricing decisions are very difficult when customer response is uncertain. But what is the right way to determine prices for smaller companies and government agencies that can’t spend huge dollars on customer research? From our experience people tend to rush to the final question: Is this widget 10 cents or 12 cents? Here’s a better approach that starts with customer and opens the questions wider to consider the pricing model and how price policy will be executed in practice. This approach is applicable in both the public sector and private sector.
Step 1: Objectives
Maximizing revenue or incremental profit is commonly an objective although that isn’t always the case. Other objectives may include gaining share, long term revenue growth, customer retention, balancing stakeholder needs, setting the value/brand association, perceived fairness, etc. Be clear as this will drive everything that follows.
Step 2: Customer value
Who is the customer? How will the product or service be valued by that particular segment? Value is relative to the other options available to the customer to address their need/problem. For example, with no other transportation options, someone may be willing to spend a maximum of $50 for a ride to a wedding, but a cab is about $15 and the cost of gas to get there is $1, so those may be the customer’s value reference points. A ride sharing service may have to be in-between. But what about paying for parking and the time and pain of finding a spot? Consider all sources of value.
Step 3: Stakeholder interests
The key stakeholder interests are highly variable by pricing decision but can include consumers and their sense of fairness (Am I being gouged or taken advantage of?). It may also include the interests of organizations. For example, one client of mine priced medical services and needed to consider patient need, doctors with different cost structures in their practices, and how a complicated pricing structure would affect communications and processing costs. Private companies often need to consider how other departments are affected.
Step 4: Pricing model and metrics
The pricing model describes the structure for pricing. For example, the price may be per dozen, per hour, per month, per user, per click, or a blend of these or a dozen other possibilities. On top of that base model is layered additional aspects such as variation by channels, customer discount, volume discounts, transaction charges, and so on.
A key consideration is complexity. Will the customer understand the pricing structure? Will your own salespeople? Simple pricing structures have been used as a competitive weapon in industries such as Telecom where one simple and predictable price per month has been a winning pricing strategy for some new entrants to the mobile telephone business.
Step 5: Price level
So, if we haven’t rushed to step 4, we can do a much better job here. We’re ready to take a look at direct competition and what our target customer is paying for services. Consider data we may already have such as how the customer has responded to various prices and promotions in the past. Consider testing if you can. How do customers react to the price in a focus or interview setting – or even better – in market.
An additional consideration is competitor reaction. If you’ve decided to go aggressively after share, might a competitor price cut impact your plan to eat their lunch?
Step 6: Pricing execution
Rarely is pricing so simple as set it and wait. Other factors come up that can result in exceptions. In what circumstances will unusual discounts or refunds be given? Who has the authority to discount and within what band around the list price? How do we ensure that errors aren’t made, which could include mistagging, errors in estimating, errors at the cash etc. Consider measuring price performance such as the difference between planned and realized margins and the discounts being given, by whom, to whom, and for what reason.
Just a Start
This post barely scratches the surface of the six steps as a book could easily be written on this process, however, the basic structure provides a starting point for thinking about pricing new products or price improvement programs.