Editor’s Note: This article was originally published by Web Marketing Today. Practical Ecommerce acquired Web Marketing Today in 2012. In 2016, we merged the two sites, leaving Practical Ecommerce as the successor.
When you go down to your local grocery store, you’ll probably find Jif® peanut butter, and maybe Planter’s®, and then perhaps a store brand, and possibly a generic brand (though generics are pretty well gone). For some product categories the store brand products are actually manufactured by the name brand companies. Yet each has a different price, and each product has a different price strategy. These are marketing decisions, pure and simple. The 4 Ps of Marketing are elements of the marketing mix that you can control. Price is one of the key elements in a winning marketing mix.
You can’t do business on the Internet without having a pricing strategy. And though it may seem pretty simple on the surface, your company’s pricing strategy can easily mean the difference between thriving and going bankrupt. A lot of factors are involved.
One of the first questions you need to answer is What are your site visitors like? Are they bargain hunters? Or do they look for excellence in customer service? Or shop for products based on their prestige value? Another important question is what does it cost you to purchase (or produce) and market this product or service? Your price will have to be above your costs — most of the time. Here are the various pricing objectives you’ll want to consider.
Two main pricing objectives stand out:
- To maximize short-term profits.
- Here you try to squeeze as much money out of sales of the product as possible, even though fewer customers may make a purchase. Your strategy may be to charge premium prices for website design services. You end up with less customers, but then dealing with a lot of customers multiplies your problems. And you can make more profit off each customer. Or you may need to maximize profits in order to satisfy an impatient boss or investor.
- To gain marketshare.
- The other main strategy is to price your service lower to gain marketshare. You may want to maximize the number of subscribers to your online Internet access business, even though you don’t make as much on each customer. But you know that later you’ll be able to sell these subscribers other services such as web hosting, e-commerce, website design, DSL, and a host of others once they get comfortable with you. You don’t make as much early, but you plan to make money later with “back end” sales.
These two objectives are the key ones to understand, though two others may also figure in.
- To survive.
- Survival is a worthy goal. Sometimes companies lower prices so they can generate enough revenue to survive short term. But this isn’t a very good long-term strategy. There’s an old joke about the businessman who said he was losing money on every sale, but he expected to make it up in volume. Good luck. Sometimes it’s better to call it quits before you lose even more.
- To help society.
- You might keep the price lower than “what the market will bear” in order to make essential products available to the consumers who would otherwise be priced out of the market. Altruism has its place. You don’t have to make as much money as possible, unless making money is your only goal. For example, I really want to keep my consulting services priced within reach of small businesses. I long to see small businesses thrive; that’s part of what makes me tick. But I also want to charge better-funded companies a more appropriate fee for the more extensive services I render them. The way I do this is to offer a standard product or service, and an economy service at a lower price, but with clear limitations.
Of course, commodities, well known products that are pretty much the same as every other similar product, are strongly affected by demand as well as supply. Take crude oil, for example. If it’s abundant, prices drop. If it’s in short supply, though, and customer demand remains constant, the price goes up. You could always sell beans or corn or pork bellies on your website. But the price would be constantly changing. You need a great product that you have more control over. Producing your own product, or getting exclusive marketing rights, of course, is best if you can do it.
But having a great and exclusive product is only half the battle. Making the customer aware of its existence and its value is the other, and that’s the role of marketing. You can increase demand by advertising and careful pricing.
Once you’ve established consumer demand, you need to estimate revenue. It’ll help to master a few technical terms:
- Total Revenueis the unit price multiplied by the quantity sold.
- Average revenueis the average price the product sold for. This is still pretty simple. Now buckle your seat belts.
- Price elasticity of demandis another concept. Think how much stretch a rubber band has in it. “Elastic demand” is when a small decrease in the price of Styrofoam cups produces a big increase in sales. “Inelastic demand” is when a small decrease in the price of cups makes only a tiny difference in sales.
- Fixed costcomprises the fairly stable overhead costs of running the company, such as lease on the building, management salaries, insurance, and a Picasso print on the wall of your office.
- Variable costis the direct cost of production and marketing. This will vary with the number of goods produced and sold, such as labor and materials used in manufacturing. It costs you more for widget makers and widget glue when you produce more widgets.
- Total costis the sum of the fixed cost and the variable cost.
- Break-even analysisis pretty straightforward. You determine the level of sales needed to cover the total costs and break even. Any sales after that start to accrue profits.
Determining that maximum profit point is a vital goal in pricing. This takes some research and then some mathematical analysis and graphing. I’m pretty excited about how a new web-based tool, Make Your Price Sell!, promises to make this research and price calculation relatively fast and easy. Without the kind of scientific study this tool enables, much price setting — of an ebook, for example — is pretty much a matter of guesswork. With this kind of tool, pricing of products and services can be determined so you can maximize sales or maximize profits, whichever you choose.
Of course, pricing isn’t just scientific. It has a lot to do with your particular niche on the Internet, and how you’ve determined you can best succeed. Here are some demand-oriented approaches to pricing:
- Skimming pricing.When you are offering a new or innovative product you can initially charge a high price, since the “early adopters” aren’t very price sensitive. Then you lower prices to “skim” off the next layer of buyers, etc. Eventually, the price will drop as the product matures and competitors offer lower prices.
- Penetration pricing. You set a low initial price in order to penetrate quickly into the mass market. A low initial price discourages competitors from entering the market, and is the best approach when many segments of the market are price sensitive. Amazon.com, for example, offers a discount price and may lose money on the first sale, but this way they gain more customers who will purchase products later at a lower marketing cost (since it costs much less to attract them back for the second or third sale if they are happy with their first purchase experience).
- Prestige pricing. Cheap products are not taken seriously by some buyers unless they are priced at a particular level. For example, you can sometimes find clothing of the same quality brand at Nordstrom as you do at the Men’s Warehouse. But because it is priced higher, Nordstrom’s clientele believes it to be of higher quality.
- Odd-even pricingtakes advantage of human psychology that feels like $499.95 is less than $500. Studies of price points by direct marketers have found that products sell best at certain price points, such as $197, $297, $397, compared to other prices slightly higher or lower. Strange, we humans!
- Demand-backward pricingis sometimes used by manufacturers. First, they determine the price consumers are willing to pay for a product using an approach such as Make Your Price Sell! (http://sales.sitesell.com/myps ) automates. Then they work backward through the standard markups taken by retailers and wholesalers to come up with the price they can charge wholesalers for the product.
- Bundle pricingis offering two or more products together in a single package price. This can offer savings to both the buyer and to the seller, who saves the cost of marketing both products separately. And the customer is willing to pay more because he perceives that he is getting a lot more, even though the cost to the seller may not really be that much more.
Here are some cost-oriented approaches to pricing that I’m sure you are familiar with:
- Standard mark-up pricing. Typically a manufacturer marks his price up 15% over his costs, a wholesaler 20% over his costs, and a retailer 40% over his costs. The retailer gets a larger markup based on the idea that, since he is closest to the end user, he is required to spend more services and individual attention meeting the buyer’s needs.
- Cost-plus pricingadds a small percentage to the retailer’s costs — and “cost plus 5%” sounds so modest in ads for new cars! Ah! If only it were that simple. :-)
- Experience curve pricingassumes that it costs a company less to produce a product or provide a service over time, since learning will make them more efficient.
Then there are competition-oriented approaches to pricing that you’ll recognize:
- Customary pricing is where the product “traditionally” sells for a certain price. Candy bars of a certain weight all cost a predictable amount — unless you purchase them in an airport shop.
- Above-, at-, or below-market pricing. Certain stores advertise “low cost” or “discount” pricing. Others price at the market, while others deliberately price above-the-market at premium prices to attract prestige buyers.
- Loss-leader pricingworks on the basis of losing money on certain very low priced advertised products to get customers in the door who will buy other products at the same time.
- Flexible-price policiesoffer the same product to customers at different negotiated prices. Cars, for example, are typically sold at negotiated prices. Many B2B sales depend on negotiated contracts.
Once you have determined the list or quoted price you can make some special adjustments still.
- Quantity discounts encourage customers to buy larger quantities, and thus cut marketing costs.
- Seasonal discountsencourage buyers to stock inventory earlier than their normal demand would require. This enables the manufacturer to smooth out manufacturing peaks and troughs for more efficient production.
- Rebates,such as $40 off Microsoft FrontPage 2000, are usually offered by the manufacturer, but sometimes a retail store will offer its own rebate. Rebates make marketing sense, since they strongly motivate sales, but often less than 50% of the buyers will remember to collect the receipt, proof-of-purchase, and rebate form, fill it out, and mail it prior to the expiration date. And, of course, the rebate is often subtracted from the list price of the item, which still has considerable profit built in. Rebate marketing is less than half as expensive to the marketer as the price cut would seem to indicate.
- Trade discountsare offered by manufacturers to distributors or resellers in their distribution chain. For example, a manufacturer may quote list price of $1000 less 30/10/5, meaning 30% off the list price to the retailer, an additional 10% off the $1000 to the wholesaler, and an additional 5% off the $1000 to the jobber. This pricing will be expected if you have an online B2B store.
- Cash discountsare sometimes offered for the costs saved from not having to extend credit and bill the buyer on an open account. This mainly affects B2B sales rather than retail.
- Allowancesmay be permitted for trade-ins (not too many trade-in cars shipped by modem though) or by a manufacturer for promotional advertising that a retailer undertakes.
- Geographic adjustmentsinvolve FOB (freight on board) pricing at the point of shipping.
Regulations on pricing
Finally, we need to note that there are various governmental regulations on pricing. If you sell outside your own country (and having a global marketplace is the beauty of the Internet!), you’ll need to familiarize yourself with laws in other countries. In the US, for example, conspiring with other firms to set prices for a product is called price fixing and is illegal. Price discrimination — different prices to different buyers of the same goods or services — is tricky. The US Robinson-Patman Act allows for price differentials only under certain circumstances. Deceptive pricing is outlawed in the US by the Federal Trade Commission. Predatory pricing, that is, charging a very low price with the purpose of driving competitors out of business, is illegal in the US under the Sherman Act and the Federal Trade Commission Act, but is hard to prove.
I’ve just scratched the surface of pricing. Left unexplored are price raising strategies, product line strategies, marginal analysis, and much more. But this will give you enough to get your imagination going.
The Take-Away Lesson
What’s the take-away lesson from all this? You need to think through and then adopt a very deliberate price strategy. Will you sell what are essentially commodities and be the low price leader? Or the service leader? Will you deliberately price low in order to penetrate the market quickly and establish first-mover advantage? Or will you price high to skim off the early adopters at a premium profit? Will you bundle several products in order to make a greater profit? Will you round off to the nearest dollar or use an odd price approach? Do you have a new or exclusive product that you can study scientifically for the best price?
Most online businesses only guess at prices — and most will be out of business in a few years as a direct result. The best online businesses are very deliberate about pricing, do their homework, and make changes quickly when necessary. Do your very best with pricing, After all, pricing is the only one of the 4 Ps of Marketing that brings revenue in rather than sending it out.
Exercise: Study carefully the pricing strategy that fits your business and your niche on the Internet. Then write the rationale for your pricing strategy in a single short paragraph.