The function of price is to make the product affordable or attractive to the target market while also reflecting the value of the benefits provided. In other words, price is an indicator of how the value of products or services is perceived by the buyers based on the pain points solved.
Three concepts need to be understood: Value, Price, and Cost.
Pricing 101
The difference between price and cost is the margin or profit, while the difference between the value and the price is called surplus, as shown below.
As in the example above, while the perceived value is P12, the price consumers buy (or the company’s selling price) is P10, giving consumers a perceived surplus of P2. This is the equivalent of what Filipinos call “sulit” (worth it). Also clearly shown here is the difference in price of P10 and the cost of P4 that gives a margin of P6 per unit. This is the equivalent of what Filipinos call “kita” (income).
Price is therefore dependent on both the utility as well as the perceived value the product or service creates. A small can of soft drinks can be bought for P50 in a small sari-sari store, maybe P60 in a 24×7 convenience store, P150 in a luxury restaurant, or P200 while hiking to the top of a mountain – all because the same product provides different value to the consumers depending on context such as occasion or availability.
Price is also the twin element of sales volume that makes up sales revenues (or Sales Revenue = Price x Sales Volume). Pricing a product should therefore be revenue maximizing without forgetting the margin and the bottom line profit the firm intends to make. The revenue maximizing price is the price that achieves the highest sales revenues, where the quantity or sales volume outweighs the price effect. As presented in the example below, the revenue maximizing price is P10 based on a hypothetical price sensitivity research, or if an item is priced P1 or P2 more, less people will buy and therefore less revenues.
Sales Revenues = Price x Sales Volume
Option 1: P10,000,000 = P10 x 1,000,000 units
Option 2: P8,800,000 = P11 x 800,000 units
Option 3: P6,000,000 = P12 x 500,000 units
Three Common Pricing Approaches
There are three common approaches to establishing a selling price, as shown below.
- Cost-based – price is based on a percentage mark-up of cost.
- Value-based – price is based on perceived value.
- Market-based – price is competitive to what is available in the marketplace.
New Product Pricing
Since new products need to be tried before consumers can adopt them, firms often launch at introductory prices so consumers can feel a greater surplus, managing customers’ fear of the risk of a new product trial. It then adjusts its prices upward after the intended trial level has been achieved in a few months.
Introductory prices should not be too far from the intended price as it may attract a totally different market segment other than its intended target market. For instance, a 10-20% introductory discount can still attract the intended market segment, but not when the introductory price is discounted 50% or more, as it may unduly attract the bargain hunters instead.
Factors to Consider in Pricing
There are internal as well as external considerations that marketers must look into when pricing their products. Internal factors to watch to ensure profitability are (1) product cost, (2) goals, (3) value proposition, and (4) business model and strategy. External factors, on the other hand, ensure that the pricing is attractive to (1) the market segment, to stimulate (2) market demand, while considering (3) competition and substitutes (direct or indirect) as well as (4) the economic and regulatory landscape. Below shows the factors to be considered in pricing.
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Josiah Go is Chairman and Chief Innovation Strategist of Mansmith and Fielders Inc.
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