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Strategic Pricing and How it Benefits You

(May 2003) posted on Tue Jun 03, 2003

Learn about common approaches to pricing and how to use pricing to stay ahead of the competition.

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By Mark Goodridge

Nothing elicits more responses in screen-printing Internet forums than a question about pricing. Typically, the initial question is, "How much should I charge?" For days afterward, replies pop up on the forum with messages such as, "I would charge...," "How can you charge that much? In my area I can't even get...," or "How can you charge so little? That won't even cover the cost of the substrate!" Two common themes are found in all of these postings. Screen printers are looking for the right price for any given job. They are also looking for a simple method of setting prices and a formula, spreadsheet, or computer program that will help them set prices easily, quickly, accurately, and profitably. This month, I'll discuss what exactly pricing is and explain various pricing strategies you can use to stay a step or two ahead of your competition. What's your definition of price? The question I have never seen posted on the Internet is, "What is a price?" Well, Goodridge, you dummy, that's because we all know what a price is. The price is what we charge for our products. You know, the number at the bottom of the invoice with the dollar sign in front of it. If I were to teach a class in business administration, which I do from time to time, and you wrote that answer on a test, I would give you only partial credit. Perhaps one point out of five--two points if I were feeling generous and you had complimented me on my choice of ties. Here are two more questions I might ask on that test: Prices should be set by: 1. the sales department, because they're in touch with the customers and know what customers will pay 2. the production department, because they know how much it costs to make the product 3. the accounting department, because they know how much you have to charge to make a profit 4. none of the above Prices are: 1. an obstacle to making a sale, to be concealed from the customers until the last moment 2. a number that expresses the total value of the product 3. calculated by adding up all the costs of making the product and adding in a standard percent for profit 4. none of the above Before we discuss an extra-credit project you can do to improve the grade you earned on the pricing test, can we agree on the importance of prices? If your business is like most, the following is true: * Prices are important because your price-setting policies, combined with your ability to make sales, establish the size of the revenue stream (the amount of money) coming into your business. * The prices you set on your products strongly affect the market demand for the product (usually the lower the price, the more you sell). * The way you set prices affects how well you compete with other businesses. * Most importantly, the way you set prices is a major determinant in how profitable your business is. If you agree with me on the points listed above, can we also agree about the importance of having a rock-solid, correct-in-all-cases understanding of exactly what a price is? Pricing defined As you may suspect by now, a price is more than just a number on a hang tag or invoice. Here's an example from my own experience. My company occasionally participated in competitive bidding for screen-printing jobs. I remember one bid particularly well. The job wasn't large, but the specifications were strict, the techniques involved were complex, and the due date was close and could not be missed under any circumstances. Mine was one of five screen-printing businesses bidding on the job. My bid was the highest of the five, but my company got the job anyway. Why? Because we understood that the number on the bid was only part of the price of the job and, in this case, not even the most important part. We got the account because we were able to convince the customer that we were best able to deliver the job produced to their specifications on or before the specified due date. Price is the amount of money and or other items or services of value with which your customer has to part in order to acquire your products. This definition, in turn, brings up the question of product. What, exactly, are you selling? Price and product are the Siamese twins (conjoined twins, if you're politically correct) of business management. In order to set prices correctly, it is vitally important that both you and your customer understand what you are selling and what they are buying. In the example above, my company was successful in winning the bid not because we had the lowest price on the bid, but because we understood better than any of our competitors what the customer was buying. Therefore, we were able to establish the price (the combination of money and services) that best met their needs. Price includes terms of payment. A price of $1000 C.O.D. is very different than a price of $1000 net 30 days, checks accepted. A third price for the same job might be $100, but with the understanding that if the first production run is accepted, then the discount on that job will be applied to a second, much larger production run. Now that you have a better understanding of what price is, let's discuss pricing strategies. You say you don't have a pricing strategy other than to try to sell as many jobs as possible for as much as possible? Permit me to disagree. I bet you have a pricing strategy and just don't know it. Below, I've outlined some common pricing strategies, the justifications for them, and their advantages and disadvantages. Profit-oriented pricing My favorite pricing strategy--the one I place in the "nice work if you can get it" category--is the profit-oriented strategy. The goals of this pricing strategy are to achieve a preset return on investment and to maximize profits. Suppose you decide at the beginning of the year that you want to make a profit of $100,000 for the year or 15% of sales, then you calculate your prices accordingly. That's profit-oriented pricing. However, it's tough to do if there is significant competition in your market. As you know, it's damn near inevitable in our industry that, no matter what you charge for a job, someone down the road will do it for 10% less. Thus, the advantage of profit-oriented pricing is that you can guarantee a profitable business. The disadvantage is that your business is vulnerable to price competition. Before I discuss the next pricing strategy, let's consider using prices to obtain a competitive advantage. If you don't understand what prices are, and if you don't understand the various pricing strategies, you won't understand how to compete effectively with prices. If you have to compete against another screen printer who does understand pricing strategies, you're road kill. Sales-oriented pricing The sales-oriented pricing strategy is most common in our industry. The goals of this pricing strategy are to increase sales volume and to maintain or increase market share. Sound familiar? Been through a price war lately? Lost market share to a competitor recently? Well, your competitor used a sales-oriented pricing strategy to compete with you. Don't you feel better now that you know that? The big advantage of sales-oriented pricing is that if you can make it work and still maintain a respectable profit margin, you will be able to steal market share from the competition and eventually drive them out of the market. The big risk is that you will potentially fail to make a profit. If you are not careful when you use sales-oriented pricing, your sales curve will go right through the roof just as your creditors take you to court to force you into involuntary bankruptcy because you can't pay your bills. You won the battle but lost the war. A more likely outcome is that you will be able to maintain a profit, but not a large enough profit to keep your business healthy, train employees, maintain your equipment, or buy new machines. Your business will stagnate--it won't necessarily die, but it won't grow, either. Status-quo pricing The third pricing strategy, and the one I believe is the second most common currently in use in our industry today, is status-quo-oriented pricing. The goal of status-quo pricing is to stabilize prices in order to match the competition. In a mature market, when all the suppliers know just about what each other's prices are, and you set your prices to match the prices most commonly charged in the market, you are using a status-quo pricing strategy. This may sound like price fixing, but it isn't. Price fixing occurs when you and several of your competitors get together and agree what you will charge for a given product. And the FBI will be looking for you, by the way. If, on the other hand, you know what prices are commonly charged in a market for a product based on your market research, and you match your prices to those in the marketplace without any direct or indirect communication between you and your competitors, that's a legitimate pricing strategy. The advantage of status-quo pricing is that it takes a lot of the uncertainty out of the price-setting process. The disadvantage is that it takes away one of your best competitive weapons--you're no longer competing on price. That may be the best you can do in your situation, but it makes other types of competition more critical. Market-entry pricing strategies Screen printers entering a new market or debuting a new product often use one of two special-situation pricing strategies. If you enter a new market or introduce a new product with higher- than-usual prices, you are using the market-skimming strategy. In the early 1980s, my company was the only one in its market area that could print respectable four-color process on T-shirts. We had the market to ourselves for about 18 months and could charge what we liked. Our profit margins for this type of work were stunning, until two or three of our competitors figured out how to print four-color process T-shirts, too. We had to drastically revamp our price list before we lost the entire market to the competition. The advantage of market skimming is that you can make much greater-than-average profits while the market lasts. The disadvantage is that, unless you have a patented or proprietary process, the high profits never last. The competition, smelling the money, will catch up with you with amazing speed, and with that goes your competitive advantage and your profit margin. The reverse of market skimming is the market penetration strategy. Remember the last time a new screen-printing business opened in your area and sent out a price list that looked suspiciously like yours? The only difference in the price list was that they changed the name, address, and phone number at the top of the page and reduced all the prices by about 10%. That's market penetration. The big risk of market penetration, of course, is that you will gain market share at the cost of forfeiting profits (see sales-oriented pricing, above). Sales are good, but profits are imperative. How to select a pricing strategy You can set prices without an overall strategy. In fact, I suspect that's how you do it now: allowing your customers, sales staff, competitors, or the needs of the moment dictate what prices you offer. One of my favorite literary moments occurs in Alice in Wonderland. (Bear with me, I'm not as far off course as it seems.) Alice asks the caterpillar which path she should take, and the caterpillar asks Alice where she wants to go. Alice tells the caterpillar that she doesn't know where she wants to go. The caterpillar tells Alice in that case, it doesn't matter which path she takes. If you don't have a goal for your business, it won't matter which pricing strategy you use. Use them all or use none. On the other hand, if you have a strong, clear vision of where you want to take your business in the next five years, a carefully selected, planned, and executed pricing strategy will be one of the primary tools for getting there. When you select a pricing strategy, consider the following factors: * your careful estimate of the amount and type of demand for the product (you may want to use different pricing strategies for different products) * how you expect your competitors to react to your pricing strategy (try to think one step further down the road than your competitors) * the interaction between your products and pricing strategy, distribution channels you use to get products to the customer, and the promotion methods you use to market the products. Oh yes, the answers to the two questions at the start of this article are "none of the above." The solutions to these questions are as follows: Pricing is a marketing function. Your marketing staff should set prices with input from the sales, production, and accounting departments. Prices are not a problem to be dealt with; they are an opportunity to develop a marketing strategy to defeat the competition, as I hope this article makes clear.


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