Every entrepreneur should know how to create a retail price strategy. It is something that you will encounter periodically, every time you will launch a new product, or every time you need to adapt the price of your product/services to the market condition.
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This is important especially for two reasons:
- In the first place, if your price is too high, your business will not be competitive, so will not be scalable.
- In the second place, if your price is too low, your business will not have the power to innovate and create new things, and it will be very sensitive to market conditions, not being able to absorb short-term losses.
Is your business a Price Taker, or Price Maker?
So, it is important, before you start, to understand how you should price efficiently. End because pricing is an ever changing matter that is influenced by many external factors, you need to have a clear Pricing Strategy that can be adapted depending on the market condition.
Depending on the industry that you are in, the business model, and the Brand Power of your business, you can be a Price Taker, or Price Maker.
Price Taker
Being a Price Taker means that the market condition, supply and demand, and macroeconomic condition will dictate the price of your product. Usually, companies that are in this place, do not have the Brand Power, nor the market share, necessary to dictate price movements in the market.
Price Maker
On the other hand, if your company is a Price Maker, it is in a far better position for long term sustainable growth. You will have a competitive advantage, your company will be able to absorb negative fluctuations in the market condition, and your profit margin will be above average. Last, but not least, your business will have budgets for R&D, which means that you will have the power to innovate and survive a price war, if challenged.
Over time, different business models tried different pricing strategies, and these allowed many approaches to be tested and improved. Personally, I have tried a few methods, and I found one that is flexible enough to be used in different business models. I found this approach in Utpal Dholakia book – How To Price Effectively?. This method is called the Value Pricing Framework.
What is the Value Pricing Framework end how to use it to build a retail price strategy?
Value Pricing Framework is a pricing strategy method that it takes into consideration the perceived value of your clients for setting prices. This is a customer-focus approach that tries to optimize the price and permanently adjusts them depending on the market condition. In this way, you can make sure that you are permanently competitive, but at the same time, you don’t leave money on the table at any point.
How to develop a Value Pricing Framework for your business?
For building an effective pricing strategy, you need to consider the most important 4 pillars of the Value Pricing Framework.
- Cost
- Customer Value
- Reference Prices
- Value Proposition
Further, you need to make sure that your marketing strategy is built in such a way that can support the four pillars of the Value Pricing Framework.
We will consider the four pillars of the Value Pricing framework one by one and make sure that you understand the link between them.
Cost
Costs are usually the most used indicator for setting the price of a product or a service. It is the most common method used by managers across all industries, even if few of them are willing to recognize this.
Unfortunately, it is an inefficient method that usually leaves money on the table. You can’t build a sustainable business by pricing your product, considering just the costs as an input. It may be the most important input, because if you set the price without taking in consideration all the relevant costs, the journey to break even will be Impossible. Therefore, COST is one of the main pillars of the Value Based framework.
Incremental Costs and Irrelevant Costs – why they are important for building a sustainable retail price strategy?
There are a few aspects that need to be discussed. First, there are Incremental Costs and Irrelevant Costs.
For building a sustainable retail price strategy, we need to pay attention to Incremental Cost. Incremental costs are the extra cost that a company incurs if it manufactures an additional units. These costs will be encounter because you will need additional raw materials, extra utilities needed, wage or direct labor that’s only involved in production, shipping and packaging.
Irrelevant Costs for setting up the price of your product are costs that your business will incur no matter what.
Incremental costs and irrelevant costs overlap, but are not identical to the well-known distinction between variable costs and fixed costs.
Cost will set the floor for the price of your product or service. It will tell you which are the minimum amount that you can charge your customers.
Further, we need to understand the distinction between LONG-TERM AND SHORT-TERM PRICE FLOORS. This will give us some flexibility when it comes to pricing.
In the long term, the average price/unit must cover both fixed and variable costs. Total costs establish the long-term price floor of the product’s price.
On the other hand, in the short term, the price can cover just the incremental costs. The additional costs that the company will encounter by producing one additional unit or by serving one additional client. This is an important thing to know, especially when you are planning promotion. This usually are calculated to cover the Incremental Costs of the product.
Customer Value
Customer value is the second input into pricing decisions. The customer value is “all the different ways in which the customer derives benefits from purchasing and using the product.” – Utpal Dholakia.
For the customer perspective: Customer value is the sum of all functional and hedonic benefits derived from the product’s features.
From the company perspective: Customer value is the total amount of money that the customer will be willing to pay for the functional and hedonic benefits received.
How to map customer benefits to economic value?
- Unbundle the product into separate features.
- Understand the hedonic and functional benefits derived by customers from each product feature.
- Ask customers to quantify the benefits in economic terms, how much they will pay for each benefit. Alternatively you can do A-B testing, even if for some products this can’t be feasible.
- Add the economic value of each benefit to calculate the product’s total economic value to the customer.
*** The perceived value of your customer will determine the ceiling for the price interval. The maximum amount that you can charge your customer.
Reference Prices
When taking pricing decisions, it is important to consider the fact that clients almost never analyze pricing in isolation. Usually, before making the purchasing decision, they use price reference. The price reference can be prices of your competition, historical prices of your company product, and prices of products that are substitutes of your product or services.
This will help you understand what the acceptable price intervals are for your potential customers. Here we need to pay attention to two different inputs:
Internal price references – which are usually the old price of the product or service that you want to sell. It is more common for products that are already on the market, and need a price adjustment.
These prices are already in the mind of your clients, and they are obtained from past purchase experiences and information got through advertisements, reviews, and word-of-mouth.
External price references – These are applicable in both cases, new and old products. Usually are the prices of your direct competitors. Time to time, this can also be the prices of substitute products.
These price intervals will help us understand what are the minimum and the maximum amount that your clients expect to pay for your product/service.
Utpal Dholakia argues that:
- “THE RANGE OF REASONABLE PRICES PROVIDES THE PATH OF LEAST RESISTANCE FOR SETTING A GOOD PRICE.
- CUSTOMERS ARE INSENSITIVE TO PRICE CHANGES WITHIN THE RANGE OF REASONABLE PRICES.
- “SHIFTING THE PRICE TO THE HIGH END OF THE RANGE OF REASONABLE PRICES IS AN EFFECTIVE PRICING STRATEGY.”
How to measure the customer range of reasonable prices?
- Define the product category.
- From interactions with your customer, try to divide the category into 3 or 4 quality levels that have meaningful differences.
- For each different quality level, find out what is the willingness to pay.
- Use the values provided by the customer to establish the range of reasonable prices by quality level and create a graph.
Use this information as an input into making pricing decisions.
Value Proposition
Philip Kotler and Kevin Lane Keller say that: “The value proposition comprises the whole cluster of benefits the company promises to deliver. It is a statement about the experience customers will gain from the company’s market offering and from their relationship with the supplier.”
The Value Propositions provide the manager with direction, constraints, and guidelines for making pricing decisions
For pricing strategy, the value proposition provides constraints on price activity. It will help you understand how Costs, Customer Value and Reference Prices are weighted in the pricing decision. The information collected at this step will be an input that will help you decide if the price of your product/service will be closer to the lower or to the upper limit of the interval.
How should your framework look at the end?
In the end, you should have a graph like the one in the picture below. This should be your guideline for setting and adapting the pricing strategy, depending on the evolution of the market conditions.
Conclusion
Every entrepreneur needs to understand how to build a sustainable retail price strategy. No matter if it is a retail pricing strategy, or a go to market pricing strategy. This is maybe one of the most important decisions that an entrepreneur will need to make constantly, quarter after quarter.
