Pricing Strategies

Identifying new market opportunities to maximize sales and profitability

By BILL HUYLER

In today’s economy, B2B companies are grappling with the challenges of protecting market share, maintaining margins and cutting costs, all while balancing the need to demonstrate their unique value to customers and prospects. In turn, the recession has brought to life the need to discover new opportunities in underserved and niche markets. Many of these opportunities can be exploited by using sophisticated technologies to identify customer subsegments and market opportunities with greater precision and sensitivity than ever before. These technologies can also help define and characterize specific market segments, creating more opportunities for increasingly targeted and effective marketing and sales campaigns.

Precise market segmentation serves many purposes, including enabling the development of appropriately targeted marketing programs, the creation of unique promotions, and the ability to better forecast sales and prioritize product development and logistics. Increasingly, leading marketing and sales organizations are using segmentation to determine the optimal pricing strategy for products, services and bundled offerings. This article will examine the art and science that goes into developing B2B pricing strategies designed to improve market and financial performance.

 

The Role of Pricing in Meeting Customer Needs

The days of one-size-fits-all pricing are long gone. Each customer needs a unique, compelling and profitable reason to do business with you. For some, price will always be a major determinant, whereas for others, it may come down to premium service, product quality, or sometimes an unknown factor that must be uncovered. If your company’s pricing objective is to capture greater market share, and you know that your product’s value varies from customer to customer, there exists an opportunity to customize your pricing strategy to maximize sales volume while keeping an eye on profitability. Here are two examples:

I once ran a focus group of automotive repair shop owners to discuss the factors that determined how to choose a manufacturer for their service parts. It quickly became apparent that I had two distinct groups of owners on my hands. Here’s why: When asked what was most important when choosing a manufacturer for service parts, one group responded 1) product quality, 2) availability, and then 3) price. This group was comprised of ex-factory trained technicians – they valued the importance of original parts quality and good inventory control.

The other group, made up of shop owners with different backgrounds from the first group, selected: 1) price, 2) availability, and lastly 3) product quality. As you can see, each group had different sets of priorities, creating distinct segments and pricing opportunities.

In another example, oil field operators demonstrated different needs when choosing equipment suppliers. For field operators, location is an important factor in the selection of a vendor because operators that have wells located offshore or on the north slope of Alaska require special equipment designed to operate in harsh environments. These customers are willing to pay a premium for the specialized equipment needed. For others having no such special requirements, price is a determining factor. As a seller of equipment supplies, understanding the value of the specialized equipment for the oil field operators can drive maximum profit in this market segment.

These examples demonstrate how a customized pricing strategy can create unique offerings for individual customer segments, depending on whether price, service or other factors are considered premium. Marketing and sales organizations understand that customer purchase behavior should define individual needs and drive the definition of unique market segments. In complex markets comprised of hundreds of segments, statistical analyses of historical transactions can uncover clusters of shared behaviors.

 

The Science of Pricing

From the many customer, product and order-related attributes that exist, the challenge is to find those that correlate best with demonstrated price response. This means that testing, sometimes with hundreds of variables, should determine what matters most and how value varies among different groups of customers. A variety of mathematical techniques can be used, from simple but less powerful tools that need little user sophistication, to those that are high-powered and require a level of expertise.

One popular statistical software package lists seven classification techniques ranging from simple classification schemes to powerful pattern recognition algorithms, such as neural networks. The more powerful ones are able to discern finer segments. Pattern recognition algorithms were developed in the 1960’s for navigation purposes before GPS. They have been developed further for other applications, such as recognizing patterns in customer behavior.

As sophisticated as statistical analysis tools have become, running the numbers is only a small part of the equation. Pricing software solution providers specializing in analytics have the software tools required to analyze the data. However, the key ingredient is teamwork between the statistical analyst and the staff that is intimately familiar with the markets and products. It is critical that an in-house market expert interpret the results and implications. In fact, raw output has been compared with the proverbial Rorschach ink blot test – what is seen depends on the eye of the beholder. Without keen market knowledge, it’s impossible to identify significant growth and profit opportunities through customer groupings.

Next, the results must be distilled down to the most important clusters based upon growth and profit potential, cost-to-serve requirements, competitive intensity, and other factors.
 

Looking Beyond Demographics

“The art of defining target markets rarely progresses beyond the assembly of somewhat dull demographics. The logical conclusion is that, if everyone is doing the same, differential advantage is difficult to attain."

-- Lord Marshall of Knightsbridge, Chairman, British Airways (as quoted in the book Market Segmentation, McDonald and Dunbar, Elsevier, 2004).

Most of the data needed to properly segment markets is maintained by modern pricing solutions. This includes customer and product information, recent sales transaction history, bid win-loss data, and so forth. In addition, current competitive and customer research findings must be considered, such as competitive intensity and individual customer priorities and satisfaction.

In addition to customer segmentation, sales and marketing organizations must consider factors including:

Product (or service) differentiation: A classic example is good-better-best variation within a product family. 

Life-cycle stage: Price sensitivity rises as products age; new introductions have advantages over others on the market and more customers are willing to pay a premium. Later, as newer products come on the market, customer willingness to pay declines.

Competitive intensity: Products in different geographies encounter different competitive environments. Price sensitivity increases with the number of competing products.

Managing Numerous Segments

The old rule of thumb of keeping the number of market segments to as few as possible no longer applies. Today’s modern pricing tools provide more automation and have the ability to support complex pricing strategies. Technologies give us the ability to manage an infinite number of segments and thereby tap more profitable opportunities. In fact, managing hundreds of pricing segments is no longer unusual. As markets continue to evolve, how often segmentation needs to be refreshed depends on certain factors, including how dynamic and complex a company’s target markets and product lines are.

More nuanced price segmentation, due in part to today’s modern pricing tools, can reveal untapped sales opportunities. If you seek new market opportunities and haven’t reviewed your segmentation recently, or if you haven’t looked at it from the perspective of pricing, consider using the latest tools and techniques. There has never been a better time to take advantage of global market trends and advanced technologies for identifying and approaching opportunistic markets.

Pricing Strategies

 

The task of adopting pricing strategies can be overwhelming for the manager or business owner who does not understand the nuances of selling to a particular market. For many, pricing is a summons to a land of confusion – where there are few, if any, absolutes to confirm that you have chosen the right game plan.

Once you know your customer base and the major trends in your industry, however, the pricing game becomes a matter of choosing a strategy and moving on it for as long as it continues to yield a profit.

If there can be any such thing as good pricing practices, there are some tenets that should always be the foundation of pricing decisions:

Understand your true costs.

It may be tempting to estimate how much things cost based on previous experience or an average cost. However, if you want pricing to be accurate, it is important to itemize the cost of every ingredient, element or process it takes to make your product. Once you have exact figures, you can then determine how much of your cost can be profit. Without precise costs, you are leaving yourself open for an imprecise profit, and most often, a loss.

Know your own company and its goals.

Your pricing goals should be about increasing your bottom line, but they should also be about helping you achieve some of the visionary goals you have set for yourself and your company. If you want to secure a certain percentage of the market by a certain time, for example, it is best to allow your pricing strategy to reflect that goal. If your goal is to secure a reputation for quality, then your pricing strategy should include premium prices, as well as a premium product, to help drive that perception home for buyers.

Know your primary customer.

Ask yourself, “Who is buying my product?” It is crucial to understand not only the quality and variety your main customer type prefers, but you must also know how much money this customer is willing to spend for your product. Since many companies cater to more than one kind of customer, it is equally critical to know these things for each customer type who shops with you. Each one has a different need, so do not ever treat them all the same.

Do not underprice.

The immediate effect of underpricing is that it does not allow you to recover the costs you invest to produce what you are selling. There is also another danger. Market items that are priced extremely low are sometimes perceived as cheap, poor quality items rather than good quality bargains. While it may be your goal to sell a high volume of items because you have lowered your price to an almost unbelievable number, your customer base may not be willing to sacrifice quality to get a good deal.

Do not overprice.

There are many ethical reasons to avoid overpricing, but the reason that should hit home with more business sense than anything else is the fact that overinflated prices drive both existing and potential customers right into the sales outlets of your competitors. Too many customer losses result in a product that will not move.

Know your competition and your market.

It does not benefit any manager or entrepreneur to exist in a market that he knows nothing about. For this reason, it is important to follow trends, know who the market leaders are and why they are leading, have a general understanding of their strategies and know which factors outside of your market will have an impact on your product for future production. Many business owners find ways to distinguish themselves from others in the same market as a way to keep a leading edge. This may involved using the same marketing strategies but changing something about the product, or vice versa. Remember pricing and its impact on sales is all about perception, so it is important to make sure that you are controlling the perception of your products among your customers.

Monitor your prices at least monthly. You have no idea how the price you set affects your profit unless you consistently are tracking what your profit does over a set period of time. This monitoring not only should include your overall profit, but it should also detail how each product you sell either turns or loses a profit. Individual products – especially if they are popular – have the power to make or break a company reputation and sales.

In addition to these basic pricing principles, there are a number of specific strategies you can employ to set your prices.

Cost-Plus Pricing Strategy

This is the most basic of all pricing approaches: you charge for the amount it takes to produce your product or service and then add in a profit. In a restaurant business, for example, each menu item is priced for the cost it takes to make the item and multiplied by three to ensure a reasonable profit. If it costs about $1.95 to make a sandwich, then the minimum cost to the customer should be $5.85. Not everyone has the same formula for making this work, but the concept is always to add a profit to the base price.

Competition-Based Pricing Strategy

Keeping track of your competitors is a basic business practice that does not always involve pricing. Sometimes, it is merely a practice to keep your company on its toes. When it is done for the purpose of pricing, however, it is a good way to stay informed about what is unfolding in your industry – and who is making things unfold. Choosing to orient your company as a competition-based company means that you will have to stay innovative to keep ahead of your competitors. Since it is also driven by supply and demand, it also means that the general public likely will get the best deal from the best company selling the product. While it is important not to be distracted by being obsessed with the dealings of other companies, it is just smart business to always have some idea of how they are delivering to their customers.

Skimming

The best example of price skimming happens frequently with computers, mobile phones and other electronics. For a short time when the product is first released on the market as a new and highly coveted item, it is expensive. Only an exclusive group of people can afford to buy the product and be a part of the elite club of those who have “access.” Once the item becomes more popular and sales volumes begin to rise, pricing falls, and those early adopters who chased the prestige move on to the next greatest new product. The benefit of this strategy is clearly short-term profit. Over time as prices fall, the pricing strategy must shift to ensure a profit.

Loss Leader Pricing Strategy

The loss leader strategy happens when you price a product at or below cost so that you can make other items that you sale more profitable. The goal is to attract customers with the low-priced item and then interest them in other higher-priced products. Customers the more expensive products help to make up for the loss endured by the low-priced product. This plan, also called decoy pricing, is seen often at department stores that sell a hot item for a very low price near an entrance or a highly trafficked area of the store – where other displays with higher priced items are strategically placed. One of the main goals here is to attract new customers who might not otherwise see any products at all. They come because of the bargain. Loss leader pricing works well for new businesses and on products that are being discontinued.

Penetration Pricing Strategy

Penetration pricing is used when a company wants to really dominate a market. They lower almost all of their prices in order to keep customers buying. Retailers who use this strategy make their profits primarily through volume sales. Large sales enable those same retailers to buy in bulk, so to speak, and receive their wares at a much lower cost per unit. This increases their profit margin. The risk with penetration pricing is that the image of the company may be perceived as lower quality because the price is lower. Most managers, though, take the risk because of the huge promise of market share that will allow them to control a good portion of the industry.

Version Pricing: Creating Lines of Products at Different Price Levels

Versioning is a way of taking a core product and creating a range of product lines based on customers’ different needs. Often, this kind of pricing creates basic, medium and premium levels of packaging. Pricing your product this way helps you serve customers with unique needs and gives you different levels of profit margins. This way of multi-pricing ensures you can tap into different segments of your market and still offer an easily recognizable –and adored – core product.

No matter which strategy you decide to use, it is important to revisit your game plan often. The market, buyers and your ability to meet demand are factors that are always in flux. It is not always best to have just one way of selling. You may have to monitor your existing sales for a while before you can determine the strategies that are right for you. Your personal pricing strategy may depend on new developments in your industry, the evolution of product itself, what customers say they want or what kinds of internal company changes are impacting your ability to deliver your product to market.

Remember, making a profit is about the sale. Making the sale is about setting the right price.