Insider’s Corner with Peter Rosenwald: Making The Price Right
Finding the right price for your product or service can make the difference between being profitable or operating at a loss.
In this issue of Insider’s Corner, our industry expert takes a closer look at pricing considerations and explains the right way to find the right price.
For a deep dive into testing, read Peter’s previous post here.
Guessing the price of something is a game we all play on a daily basis. It’s no surprise then that since 1956 when it premiered, The Price Is Right has persevered in its various iterations to become the longest running game show in TV’s abundant history of game shows.
Perhaps that’s because, as we marketers know all too well, getting the price of our product or service right is one of our toughest and most important challenges.
Let’s Make A Bargain
In UK usage, it’s called a “bargain” when someone makes an offer to buy something and the offer is accepted. In US usage, a bargain tends to mean that someone made a “good deal” by purchasing something for less than it would normally cost. Ideally, we want every purchaser to feel that he or she is getting a bargain, especially when we, the sellers, are also enjoying our end of the bargain.
Determining the right price to accomplish this happy event is both complicated and subject to a host of difficulties. And, there are a zillion strategies to employ, certainly too many to detail here. This screen shot from the results of a Google search for “pricing strategies” shows that marketers can’t even agree on how many are important.
This overview from EDUCBA helps focus the issue:
Understanding the market conditions and the unmet desires of the consumers along with the price that the consumer is willing to pay to fulfill his unmet desires is the ultimate way of gaining success in the pricing strategy of a product or a service.1
The True Cost
Obviously, if there is a definable cost to what is being offered, the first thing to establish is what the true “cost” is. Where possible, we at least wish to cover all our costs, including a significant contribution to general overhead and profit. No one would question that the best pricing strategy maximizes our profit and revenue. The bottom line is, after all, the reason we are in business.
Cost-based pricing is the most obvious place to start. If we are marketing widgets, determining the costs should be fairly simple. We know what they cost to make and deliver, and we know how much it costs to handle the details of payment and fulfillment. Add to these the desired overhead and profit contribution, figure out what you are going to pay for marketing per unit, and you have a baseline price. This baseline, however indicative of minimum pricing considerations, is little more than a useful indicator and a good starting point.
Now the fun begins…
How Low Can You Go?
Price elasticity is critical to your pricing strategy, but how elastic can your pricing be?
In the most recent Insider’s Corner, we focused on testing and suggested that you should only test the items which you can change and which can materially impact results, such as offer, price and media. Testing prices, one against another, should provide you with an inexpensive way of determining which is likely to be the most profitable and where you have the maximum price elasticity. Drilling down and testing different prices to different cohorts from your prospect universe can be a major success determinant and can help you optimize your pricing strategy.
Imagine that the baseline price is $100.00 which includes a 25% ($25.00) overhead and profit contribution. You are reasonably certain you can sell 1,000 units, delivering a profit of $25,000. Assume now that by reducing the price (through a discount or another mechanism) to $89.99 you could sell more than 1,000 units. Assessing the competition and other market conditions, is it reasonable to assume that you could make more than 2.5 times as many sales at the reduced price? That’s what you would have to do to make the same profit.
A Diner’s Club Case Study
In the early days of the credit card business, there were many more establishments that accepted Diners Club than American Express, yet both cards were priced at an annual fee of $15.00.
If memory serves, in an aggressive pricing-based advertising campaign to recruit American Express cardholders, Diners Club headlined this offer: “The President of Diners Club Wants to Buy Your Used American Express Card.” The offer was that if you had, say six months left on your American Express card, when you paid the $15.00 for your annual Diners Club membership, Diners Club would give you back $7.50. And, as they whispered so seductively, you would have the two cards to use for the price of only one.
Understanding pricing for the card business is how Diners Club could afford to make this offer.
One of the large costs in offering credit cards was credit checking. This was a necessary cost in order to be as certain as possible that the cardholder would be able to pay their credit card bills. Knowing that anyone who had a valid American Express card had passed a more rigorous credit check than was used by Diners Club, this significant cost could be eliminated, saving Diners Club more than the average they had to pay for used American Express cards.
It was enormously successful until American Express countered with an unexpected and brilliant move, again based on an understanding of pricing. They raised the annual price to $20.00 making it too expensive for Diners Club to continue the offer. As a side benefit, the increased pricing implied that an American Express card was superior.
The Bottom Line
What we must all remember is that the price is right when the consumer perceives a “bargain” received at the moment the seller maximizes his objectives and profits. Getting as close to that point as possible is our pricing challenge.