Before you set your exact price, you must decide upon a pricing model -- this strategy should be consistent with your overall business model. Pricing always needs to accomplish a goal...
… but that goal is not always to make the most money, especially when you are selling on the Net.At the risk of oversimplification, there are two basic business models, each with its own objective. We’ll very briefly examine a few less frequently used models afterwards.
OK. Let’s get the ball rolling…Model #1 Price to Penetrate
Your goal is to penetrate the market fast and deep. In other words, sell as many of the item as possible. So you set your price low. But how low?
There’s no point in giving away the store. You want to find the highest lowest price that maximizes profits and number of units sold.
Use this strategy to establish a powerful position in the market quickly. Why? The basic goal is to acquire as many customers as quickly as possible. Taken to an extreme, you might even price at a loss. Why?
For this powerful reason… each customer has a lifetime value. That value can be hundreds of times greater than some small gain you might make on the first sale. With this knowledge, you are happy to reduce or forego that first profit.
Penetration pricing is especially appropriate if you sense that more competition is on the way. Lock in the people who see your product being offered now.Key point... penetration pricing only makes sense if you keep those customers. There must be a strategy in place to realize that lifetime value. Here’s a quick primer on how to convert “first-time” to “life-time.” Feel free to mix and match...
1) Stickiness -- this is customer loyalty with a twist. Once someone buys from you, does it quickly become too costly for her to switch to a competitor? (high ‘switching costs’). The costlier it is to switch...
... the stickier is your product.
Offline example -- Shaver handles used to be expensive. And they only fit a certain brand of blade. The cost of switching to another brand was the cost of buying another expensive handle, so customers had to continue to buy expensive refills. Hence that old phrase... the “razor-and-blade” strategy.
Online example -- Consider the amazingly cheap online brokers... It takes a while to learn a system and set everything up. Bingo!A sticky product... The customer doesn’t want the hassle of switching.
2) Great product -- an outstanding product guarantees the customer’s return. You know that she’ll be back!
Offline example -- Shaving companies realized that they could make much more money, in the long run, from the resale of razor blades than from the handles. They started to sell the blades at give-away prices. The customers got used to a good shave with relatively inexpensive blades and just kept on buying those profitable refills. Hence that old phrase... the “razor-and-blade” strategy.
Online example -- Good books and good prices are a winning combo. Amazon.com has discounted deeply in order to dominate the book (and now every other category!) market in cyberspace. They were losing massive amounts of money due to discounting. But they were building a massive base of customers... lifetime customers. And now the profits are starting (finally).
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Of course, that’s the way an accountant thinks. If you think like a business person, it’s worth a heck of a lot more than that. After all…
What are hundreds, even thousands of new lifetime customers worth to you? What are entirely new income streams worth? More to the point, what is it worth not to waste a year or two of your life, and thousands of dollars, doing what everyone else is doing, and failing?
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3) Freeze-out -- this is a variant of great product. You offer an “introductory low price” for a product that is a recurring purchase for a customer. That first sale effectively sticks him to you, not your competitor... if the quality is there, of course.
Offline example -- Buying a long term membership in one gym, keeps you from joining another one. You don’t join two gyms. Also, magazines -- most people purchase Time or Newsweek, not both.
Online example -- Web hosting services often offer low “first year” rates to take customers out of their competition’s hands. Then as long as they offer good Web hosting, customer stickiness takes over.
What’s the bottom line?
If you want to establish dominance in the market for any reason, price to penetrate... even if it means you have to accept low or no profit margins. This pricing technique, referred to as “buying market share,” comes at a “cost”, no doubt about it. You are foregoing the additional profits of a higher price to “buy” this larger percentage of the market.
There is one school of thought in marketing that says that “market share dominance” is the most important factor in the marketplace. The Net raises the bar to alpine levels...
If you’re pricing high on the Net, you better have a unique and patented product. Even then, you’re begging for someone to attack you with vicious price-cutting.
Model #2 Top Pricing
The opposite strategy to penetration is top pricing. Here the price is deliberately set high in order to reap large profit margins. This is usually at the cost of failing to capture a large number of customers.
The most valid reason to use this price strategy? You are launching a hard good that is radically new and significantly better than the competition, and you have strong patent protection. The high price attracts and does not deter “pioneers.” This strategy helps to recoup your capital costs.
Who, or what, are...
... pioneers?
They are people who want something that nobody else has yet. Pioneers are not afraid to be “first” or “unique” -- actually, it’s a badge of honor to be “first one on the block.” They are not particularly concerned about price. Often, to their way of thinking, high price indicates quality.
Such must-have, open-wallet customers are your best friends. If you can equate uniqueness and quality with your price statement, substantial profit will surely follow. In the short term, you receive a good income from the highpriced product. But...
Long term, this comes at the cost of establishing a powerful position in the market by dominating market share (i.e., percentage of the customers). So don’t stick with this strategy forever.
High prices tend to attract competitors. They see your big, fat profit margins. They know they can offer a similar product, at a much lower price than you are doing, and still take home a fair penny.
High price tactics are also known as “selling off market share.” You gain income from those high profit margins, in exchange for having a smaller and smaller percentage of the market buying your product.
There are other valid reasons for top pricing, besides “pioneer pricing.” For example... Luxury pricing … You make a top quality product, among the very best of its kind on the market. You are able to create a certain “luxury cachet,” building a high perceived value. You accept smaller unit-sales in return for higher margin. To thrive long term, of course, you must continue to offer a “best of breed” product and maintain the luxury image.
Pricing a service… If you offer professional services, you may find it preferable to cater to a small number of high-paying clients. Of course, you have to be able to “walk the walk.” A diametrically opposite strategy for your same service would be to offer a “cookie-cutter” service to “the mass market” at a much lower price.
Offline example -- Apple sold the Macintosh computer (with its unique-at-the -- Apple sold the Macintosh computer (with its unique-at-the $1,500 above that of the PC clones. That was successful for a while, especially while the competition was pre-Windows 95. In the long run, though, their lowered sales volume allowed IBM and its clones to become the industry standard. Mac almost died as a result.
Offline example -- The DVD. Pioneers covered the R&D costs and delivered fat profits. Over the years, the DVD became fiercely competitive and prices evaporated. Today, it’s a commodity.
Offline example -- Mercedes Benz is an excellent example of luxury pricing. Unlike the VCR, Mercedes can sustain its top pricing model for as long as it delivers a superb automobile and maintains the image.
Online example -- High-end design companies capture a niche market based on their uniqueness which can’t be copied. These companies usually can only handle a limited number of clients at a time. Customers are willing to pay a higher price for this selective service.
Before you adopt this strategy, remember that market penetration (i.e., unit sales) will be hurt. Does that make a difference to you? If so, then decide when you will switch strategies.
Be careful, though. You have to carefully watch the public relations side of this. If people hate your company for taking advantage of them, your death will be quick and painful. One thing Macintosh always did right -- their users loved (and still do!) the Mac. They never felt gypped, even though they could have bought comparable computing power for far less money.
It applies to services, too…
Professionals and consultants often don’t give enough thought to the rationale behind how they price their services. Basic goal-setting and strategizing upfront will clarify matters. For example...
Pretend that you are in the price consulting business. One of your services sets up pricing surveys for companies .Let’s examine two scenarios...
Scenario #1, Top pricing -- you don’t want to grow a huge consulting business -- you just want to support yourself and shoot a few games of pool the rest of the week. So you charge a higher price, $500. The last thing you want to do is to have too many clients, which means working more hours per week and making the same (or less) money. Instead of shooting pool, you’ll be...
... behind the 8-ball!
Scenario #2, Penetration -- you want to use this pricing service as your “foot in the door” for your higher-priced services. You don’t mind breakingeven or possibly losing some money in return for more customers. Each customer has a lifetime value, in terms of future business, referrals, etc. So you may decide to offer this service for $100 as an “introductory offer.”
Model #3 Price to KillLarge companies will often price a product at a great loss, just to drive smaller competitors out of the field. In many cases, it’s not strictly legal. But who has the resources to fight gray-zone cases?
Model #4 Price to LoseDo you know the irony of the “price to penetrate” and “price to kill” models? Most of us do neither... or both, depending on how you look at it.
Let’s say that you price to penetrate -- you want to pick that price that finds the most customers, right?
Let’s say that you top price -- you want to pick the price that makes the most money, right? Unfortunately, most business people tend to skew a penetration price too high, trying to make more money. Likewise, top “pricers” tend to worry about scaring too many people off.
Don’t price in that in-between “No Man’s Land.” Decide whether you want to price to penetrate or to get the top price.
Now apply this information to your business. Ask yourself these questions…1) What was my goal when I chose my pricing model originally?
2) Knowing where I am now with my business, should I have chosen a different approach?
3) What are the pros and cons of my pricing strategy?
4) Which model do I see myself using three months from now… with confidence?
Pricing is a complex topic for almost all of us. The key is to look at it from different angles. Each new perspective gives different chunks of information to increase your understanding of pricing theory and how it affects your business.
Finished with the reflection exercise? Good timing. The next “angle” is stepping up on the podium…