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Pricing |
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| What is Pricing? | |
| Pricing is an important component of an enterprise's business processes and financial performance. Companies can face a variety of pricing problems such as unnecessary discounting and quoting prices below breakeven. We believe that improving pricing is one of the most strategic and powerful ways for companies to improve their business and financial performance. According to a 2006 Gartner Research report, on average, a 1% improvement in price translated to an 11% increase in profitability. By contrast, according to the same report, a 1% improvement in fixed costs or in variable costs only increases profitability by 3% and 7%, respectively. | |
| The Pricing Problem | |
| We believe most companies have yet to develop and implement pricing technology solutions that improve financial performance. We believe this failure creates a pricing problem, the key components of which include | |
| Limited visibility into the pocket price and pocket margin | |
| The pocket price is a measure of the effective price paid by the customer in a particular transaction after accounting for all relevant discounts, promotions, rebates and allowances. The pocket margin is a measure of the profitability of a particular transaction determined after subtracting direct product costs and other costs attributed to a customer from the pocket price. Companies can face challenges in determining the pocket price and pocket margin of their products due in part to the lack of timely access to relevant data. Without an accurate view of the pocket price and pocket margin, it is difficult for companies to determine the profit contributions of products, customers or individual transactions. Additionally, many companies are often unaware of trends in pocket prices and pocket margins. As a result, they have difficulty in determining the economic impact of changing prices, optimizing current prices or forecasting future prices. | |
| Lack of uniform pricing and goals | |
| We believe most companies do not have a centralized process for managing overall pricing or communicating and enforcing pricing policies consistently across sales channels and business segments. As a result, sales representatives often negotiate and quote prices that do not support corporate business goals or financial targets. The absence of uniform pricing policies and goals across an organization leads to conflicting practices among various internal functions, such as sales, marketing and finance. | |
| Unscientific, ad-hoc approach to pricing | |
| Most companies rely on a combination of manual processes, external consultants, spreadsheets or internally developed software tools to conduct pricing activities. We believe current pricing decision support tools often are unable to efficiently process large volumes of data, lack sophisticated mathematical tools or generate inaccurate pricing information. Because of the difficulty in analysing data in a scientific manner and setting optimal prices, we believe many companies often set prices in an ad-hoc manner. As a result, they are also unable to track prices and analyse pricing performance, such as the response in demand due to price changes. | |
| Lack of complete, relevant and timely data | |
| Companies have access to large quantities of data generated by traditional enterprise applications spread across complex global information technology environments. This dispersed data is difficult to aggregate, or make available in a timely fashion. Additionally, internal systems often lack market data and the capability for real-time processing over numerous complex transactions. As a result, most companies today do not have the necessary and relevant information to make data-driven pricing decisions at the time of sale. | |
| Market Opportunity | |
| The potential for business and financial improvement from pricing software solutions has generated increasing focus on addressing the pricing problem through pricing and margin optimization software products. We believe companies have only begun to realize the benefits from these solutions. | |
| A comprehensive pricing software solution should provide: | |
| Pricing Analytics | |
| The ability to analyse market and historical data to provide price insights that might be otherwise hard to identify. | |
| Pricing Execution | |
| The ability to propagate pricing decisions to either users or to another enterprise application, such as a CRM or ERP application, in order to offer frontline sales representatives easy-to-use guidelines that help them in quoting a profitable price. | |
| Pricing Optimization | |
| The ability to determine and forecast the price sensitivity of a product or a market segment and to generate optimal pricing to achieve business goals such as maximizing margin or improving market share. | |
| Pricing Analytics | |
| Determine pocket price and pocket margins by discrete elements, such as customer, product, channel, plant, sales territory and country; | |
| Understand how various price and cost elements contribute to the pocket margin; | |
| Understand detrimental pricing trends; | |
| Understand the components of margin variance, including price, cost, volume, product mix and exchange rate effects; | |
| Understand differences in segment purchasing behaviour; | |
| Proactively monitor pricing performance and market conditions; and | |
| Determine how individual customers contribute to overall revenue and profitability. | |
| Pricing Execution | |
| It allows organizations to create multiple rules-based price lists and quickly modify prices or guidelines in response to changes in business conditions or strategy. Specifically, it enables our customers to: | |
| Create and manage pricing policies and rules that are aligned with corporate strategies; | |
| Automatically generate mass price updates when pricing inputs change, including costs, competitor prices, market indices, supply availability or demand metrics; | |
| Set up and manage field pricing and discounting guidelines based on pricing policies and benchmarks; and | |
| Manage pricing approval and exception thresholds and the pricing approval work flow to ensure consistency in the pricing process and maintain transaction histories. | |
| More accurately understand transaction economics including the impact of discounts, rebates, allowances, shipping terms, payment terms, replacement costs and other factors that can influence the profitability of a transaction; | |
| Communicate price targets, price floors and profitability guidelines to appropriate decision makers within an organization; | |
| Consider important transaction context to aid in better price negotiations, including insight on customer price history and willingness to pay, current and planned inventory levels and recent trends in demand, supply, cost or competition; and | |
| Evaluate transaction scenarios and allow comparisons to previous transactions and peer group benchmarks based on relevant metrics | |
| Pricing Optimization | |
| Helps companies arrive at an optimal price by analysing the relationship between demand, price and profit margin. By analysing these relationships and taking into account operational and financial constraints | |
| Analyse and understand factors that influence demand in conjunction with price; | |
| Understand customer or segment price elasticity's and customer indifferences or cluster customers into segments based on purchase behaviour; | |
| Construct and execute price testing to systematically manage and evaluate results of price changes; | |
| Forecast demand and demand response using a library of forecasting algorithms that support a vast number of business scenarios and that consider relevant variables; and | |
| Run optimization algorithms and apply appropriate methodology to recommend optimized prices or other business controls. | |
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Pricing Strategies. |
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| Use a high price where there is a uniqueness about the product or service. This approach is used where a substantial competitive advantage exists. Such high prices are charge for luxuries such as Cunard Cruises, Savoy Hotel rooms, and Concorde flights. | |
| Penetration Pricing. | |
| The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is increased. This approach was used by France Telecom and Sky TV. | |
| Economy Pricing. | |
| This is a no frills low price. The cost of marketing and manufacture are kept at a minimum. Supermarkets often have economy brands for soups, spaghetti, etc. | |
| Price Skimming. | |
| Charge a high price because you have a substantial competitive advantage. However, the advantage is not sustainable. The high price tends to attract new competitors into the market, and the price inevitably falls due to increased supply. Manufacturers of digital watches used a skimming approach in the 1970s. Once other manufacturers were tempted into the market and the watches were produced at a lower unit cost, other marketing strategies and pricing approaches are implemented. | |
| Premium pricing, penetration pricing, economy pricing, and price skimming are the four main pricing policies/strategies. They form the bases for the exercise. However there are other important approaches to pricing. | |
| Psychological Pricing. | |
| This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example 'price point perspective' 99 cents not one dollar. | |
| Product Line Pricing. | |
| Where there is a range of product or services the pricing reflect the benefits of parts of the range. For example car washes. Basic wash could be $2, wash and wax $4, and the whole package $6. | |
| Optional Product Pricing. | |
| Companies will attempt to increase the amount customer spend once they start to buy. Optional 'extras' increase the overall price of the product or service. For example airlines will charge for optional extras such as guaranteeing a window seat or reserving a row of seats next to each other. | |
| Captive Product Pricing | |
| Where products have complements, companies will charge a premium price where the consumer is captured. For example a razor manufacturer will charge a low price and recoup its margin (and more) from the sale of the only design of blades which fit the razor. | |
| Product Bundle Pricing. | |
| Here sellers combine several products in the same package. This also serves to move old stock. Videos and CDs are often sold using the bundle approach. | |
| Promotional Pricing. | |
| Pricing to promote a product is a very common application. There are many examples of promotional pricing including approaches such as BOGOF (Buy One Get One Free). | |
| Geographical Pricing. | |
| Geographical pricing is evident where there are variations in price in different parts of the world. For example rarity value, or where shipping costs increase price. | |
| Value Pricing. | |
| This approach is used where external factors such as recession or increased competition force companies to provide 'value' products and services to retain sales e.g. value meals at McDonalds. | |
| Price Setting: How to set your prices effectively | |
| How to Price Your Product or Service | |
| Setting prices is considered a "black art" by many people in business. Yet your ability to effectively set prices has a profound impact on the success and profitability of your business. There are 2 very simple activities you can complete to get a better grip on your pricing. In this article we will outline those 2 activities and some very simple exercises you can complete to begin pricing more effectively. | |
| What is "effective" pricing? | |
| Effective pricing achieves a number of outcomes for your business. It: | |
| Maximises your profitability | |
| Focuses clients on the outcome and value delivered | |
| Enables you to have healthy cashflow | |
| Builds competitive differentiation | |
| Delivers your business strategy | |
| Improving your pricing strategy isn't just about putting your prices up. You need to think widely about the implications for your business. | |
| The facts about pricing strategy: | |
| There are a number of different ways to go about setting prices | |
| Each method has its strengths and weaknesses | |
| The key to setting prices effectively is to learn what you can from each method and use that knowledge to identify an optimum price | |
| Whichever method you go with there will be a degree of experimentation before you discover the optimum price. | |
| 1. Use Different Pricing Methods | |
| There are a number of pricing methods you can use to determine the most effective price for your product or service. Most industries by tradition have a dominant pricing method they use. For instance, professional service firms traditionally charge by the hour. Commodity products such as some food items charge at the going rate. | |
| Here are a list of the most common pricing methods and how you calculate them: | |
| Hourly rate : Desired income level divided by potential hours of work | |
| Cost plus : Adding a standard mark up to the cost of the product / service | |
| Value based : Determine what the buyer perceives as the value of the product | |
| Proportional : Price set in proportion to a larger project / product / sale | |
| Going rate : Charge the same as your competitors | |
| To begin understanding your optimum pricing point try applying some of these different pricing methods to your situation. | |
| Choose one of the pricing methods from the list above that you haven't used so far. Imagine that method was the only one available to you. How would you need to change the way you structure and position your products or services to utilise that pricing method? What price would you choose? | |
| Experiment with a few of the different pricing methods and some trends will start to emerge. Your calculations will tend to all arrive back a certain price range. This gives you the ballpark of where your pricing should be. | |
| 2. Test Price Elasticity | |
| Price elasticity is a term from economics that describes the extent to which a market will wear changes in pricing. Most business owners don't understand or appreciate just how elastic prices are in their markets. The case studies provided by Eyes Wide Open clients suggest most customers of small businesses will easily absorb a 5 - 15% increase in prices with indifference. That sort of increase has a direct, positive impact on your bottomline. | |
| We find business owners tend to simply forget that they can experiment with their pricing. Large corporations do it all the time, just look at how our supermarkets and petrol stations change their prices so as to optimise their profitability. We need to learn from their example. | |
| There are a number of ways to test price elasticity. When working with our clients we typically suggest they start testing on a segment of their total customer base. If you are a service firm then you may choose to test with C or D level prospects. If you are in retail you may choose to do your tests on different (perhaps quieter) days of the week. The idea is to test your pricing on a contained low risk segment of your customer base to limit any negative implications if you get it wrong. Then simply start to increase your prices in small but measurable increments. Perhaps you put your prices up by 5% and see the reaction. Then 10% and again wait and see the reaction. If you work on commissions perhaps increase commission by 1% at a time. You will know when you hit your upper limit because people will start to hesitate to purchase. | |
| Solid Marketing Strategy Required | |
| Experimenting with different pricing methods and testing for price elasticity are 2 methods you can use to help you set prices more effectively. However you need to remember that whatever price point your choose it can only be delivered and sustained through effective marketing. You need to ensure your market clearly understands your value proposition and benefits otherwise they are unlikely to pay for your goods and services no matter what price you charge. With all that said, keep your mind, and eyes open, to the possibilities of pricing strategy and use it proactively to drive the success of your business. | |
| Breakeven | |
| In business, specifically cost accounting, the break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even". | |
| Sales $100,000 | |
| COGS 25% $25,000 | |
| Gross Profit $75,000 | |
| Variable Expenses $40,000 | |
| Fixed Expenses $35,000 | |
| NPBT $0 | |
| Units 10,000 | |
| Selling Price per unit $10 | |
| COGS per unit $2.50 | |
| Total Expenses/(SP-COGS) | |
| $75,000/($10-$2.50) | |
| Units needed to sell to breakeven | |
| 10000 | |
| You would like to have a 20% NPBT | |
| Units needed to sell to do so with the same overheads | |
| Sales | |
| COGS | |
| Gross Profit | |
| Variable Expenses | |
| Fixed Expenses | |
| NPBT | |
| How Do We Determine Price? | |
| • What are your costs to produce a service, or buy a product? (Direct and indirect.) | |
| • What is the customer prepared to pay? (The urgency of market demand.) | |
| • What are your competitors charging? (Market research data) | |
| • Charge enough to make a profit. (How much do you want to make?) | |
| What are your costs to produce a service, or buy a product? | |
| We need to analyse our budgeted financial statements to be able to determine what overheads we need to recover if we want to make sure our business is going to be financially viable. Careful monitoring of the actual costs & expenses against budget is imperitive to ensure that the business remains solvent and profitable. | |
| Costs & expenses from the profit & loss statement need to be determined but allowances need to be made for capital expenditure contained in the balance sheet. E.g. The repayment of business loans, payment of leases, These loans & payments are going to affect our cash flow. | |
| What is the customer prepared to pay? (The urgency of market demand.) | |
| Supply & demand are important factors. How unique is your product or service? | |
| Is their a shortage of services or the required products? | |
| What are your competitors charging? (Market research data) | |
| Careful monitoring of your competition is crucial, not only for the prices but also for levels of service. Sometimes customers will pay more for a product lor service if they are receiving superior service levels. | |
| Charge enough to make a profit. (How much do you want to make?) | |
| How do we know what to charge? | |
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| http://www.investopedia.com/terms/r/returnoninvestment.asp | |
| Definition: | |
| Return on Investment (ROI) is the profit generated by the money a business owner puts into the business. ROI is usually expressed as a percentage return. | |
| One way to calculate ROI is to divide the company's annual income or profit by the amount of the original investment (or current investment). ROI may also be expressed in terms of "opportunity cost," or the return that the owner gave up to invest in the company. For example, a business owner could easily take his/her money and invest in the stock market for an annual return of, say 5 percent. If this same money is invested in a business, a return of over 5 percent might be considered an acceptable ROI. | |
| ROI may also be expressed in terms of a specific amount of money for a specific project. For example, if the company invested in an advertising campaign, it could calculate the sales generated by that ad campaign and determine an ROI - did the ad campaign generate an acceptable return on the investment? | |
| As from above | |
| $44000 = | |
| $220,000 |