A friend of mine was once asked in a job interview to develop a value of a particular chair in the room. My friend proceeded to use different financial valuation techniques, including sum of parts, trying to account for the price of the materials used to make it. After he was done, the interviewer simply said the chair was worth as much as someone was willing to pay for it.
When choosing a pricing strategy, that is an essential concept. The chair isn’t worth the summation of its parts any more than your product or service is, it’s worth what people are willing to pay for it. Choosing a price appropriate for your product and market is extremely important, but challenging. If you get it right, sales and profit will flow, if you get it wrong, you might become just another failed business statistic. It’s also very difficult to change prices once they are set due to the various signals it sends to the market.
Here are three things we think are critical to consider when setting prices:
Although you may be in the market of say sunglasses, for example, different companies target different market segments. Oakley targets the affluent – people who care about fashion and brand name products. Pugs targets travelers on the highway who forgot their sunglasses at home and need a $10 pair to get them through the weekend, as well as less affluent people who can’t drop $200 on a pair of shades. Ask yourself questions such as how affluent your target market is, what’s the age range, and what are your geographic boundaries. Also ask yourself what kind of value these consumers are looking for and what they would be willing to pay.
Competition plays a key role in business strategy, with many markets getting ever more competitive. It is important that you have a good grasp on what is going on in your particular market and who the players are. Who are your direct competitors and what are they offering? How much are they charging? How is their product different from yours? Although the competitive landscape is good to know, you shouldn’t obsess over it. As a company your focus should be creating value for customers.
The Boston Matrix
The Boston Consulting Group created a diagram in 1970 as a tool to understand where companies fit in the market. This can be very helpful in determining prices, so let’s walk through it. The matrix plots market growth against market share, with the high growth, high share company represented as “stars” and the low growth low share companies as “dogs,” and question marks and cash cows in between. This can help us approach pricing by determining how much market share you have and what kind of growth the market exhibits. The more market share you have, the more you can raise prices without the threat of competition. The higher the growth of the market, the more room you potentially have to grow, increasing prices along the way.
Stars don’t have much of a problem with pricing since they have a high market share in a high growth segment. These are companies like Apple who profit from higher prices without running a very high risk of losing market share. Cash cows have high market share in a slow growing market, which makes a pricing strategy that maximizes profits very beneficial. Question marks struggle because of their low market share, despite their presence in a high growth industry. These kinds of companies have to offer lower prices to gain market share, otherwise they will be overcome with larger companies. Dogs have the biggest issue, and for the most part should re-evaluate their position and business model.
Whatever your approach is, never underestimate the power of pricing strategy. I’ve seen companies here in Utah bleed hundreds of thousands of dollars because they were pricing too low and others loose market share because they were pricing too high. Take some time to think this through and set the correct price.