Setting Price

1.Price Setting Is A Difficult Step

One of the most difficult tasks for a small business operator is in the setting of realistic selling prices.

The business person has to be careful that they do not undersell, as this will reduce profits, whilst at the same time they should be aware of overpricing commodities, which would be done at the risk of losing customers. Pricing is a complex strategy which should be carefully undertaken and regularly reviewed.

2.Pricing Can Determine Profit Or Loss

There is probably more money won and lost each year through pricing and price promotion tactics than through all the other marketing decisions combined.This highlights the necessity for Management to undertake careful review of all aspects of setting prices before doing so. Price setting is just as important as market awareness, product development and advertising. You can do all of these things in an excellent manner and then undo it all by setting prices too low or too high.


3.Pricing Fallacies

(a)There are a number of common fallacies relating to price setting. These include:

Price is the only thing about which customers worry
Low priced products are more successful in a recession
It is best to set your prices at the same level as your competitors
Price low to gain market entry and once market entry has been obtained - then increase prices
Ask your customers what the price should be and price at the prices that they tell you

(b)The pricing strategy shouldn’t be that the business’s prices have to be the lowest in the market to attract customers.

(c)There is no doubt that price is of concern to customers, but it is not the only thing that customers consider when deciding whether to purchase goods or services from a particular business.

(d)Astute customers tend to choose suppliers primarily for reliability. Other factors which enter into the buying decision include:
Quality
Technical and backup services
Reputation
Brand associations
Location
Guarantees
Refund Policy

4.What Is Your Customer’s Cost?

(a)Another fallacy is to equate the customer’s cost with your cost. A cost from the customers point of view includes:

the risk of interrupted supply
poor quality
ineffective service
no back up etc.

(b)“Cost” also includes other costs of doing business, such as:

hassles when placing orders
location
inconvenience etc

(c)What all this means is that the price that you charge your customer is not the customer’s final cost and is not the only thing the customer takes into account in determining his/her buying decision.

5.Why Do Your Customers Buy?

(a)You need to analyse your customers and understand why they buy and why they have not already bought from your competitors.

(b)It would also help if you could ascertain who were their previous suppliers.

For further information, refer to Paper 18.20 - "Customer Knowledge and Service".

6.Competitors Intelligence File

(a)It would greatly assist if in your competitors Intelligence File you have recorded information on each of your competitors relative to their:
selling prices
back up service
reputation
reliability
location
technical knowledge etc

as this will greatly assist you in determining on which of the “buy decision perspectives” that the customer is interested in talking to you. By undertaking this type of analysis you may decide that price is not a heavily weighted item in the customer’s buying decision.

(b)In the market place there are many businesses which charge 5%, 10% and 20% higher than their competitors, yet still run very sound profitable businesses. In many cases the businesses charging the higher prices are the most successful businesses. They have achieved this because of excellence in the other items which affect the buying decision of a customer including:
reliability
reputation
back up service
technical knowledge
location
understanding the customer

For further information, refer to Paper 21.13 - "Competitors".

7.Customer Decision Process

(a)The customer will ultimately decide what they are prepared to pay to purchase the product but in so doing they have taken into account a whole range of issues including:
features of the product or service
product quality
service or warranty

(b)This means that business people need to know their customers and understand why particular customers are buying from them as part of the evaluation of the price setting equation.

8.Understand Customers Perception On Pricing

(a)Some people advocate the only way to build market share in a competitive market is to price low to gain market entry and then price upward once desirable market penetration has been achieved so as to increase profit margins.

(b)This tactic is undertaken with many potential risks.

(c)Once you have introduced a product at a low price it creates a low price/value relationship in the consumers mind.

(d)Once there it is very difficult to remove.

(e)That is not to say that it cannot be done, but the advertising, marketing and promotion expenditure required to change that price/value image at a later date can be very expensive.

(f)Understanding a customers perception of your pricing is one of the key elements in developing pricing strategies for business people.


9.What Are The Business’s Overheads?

It is essential that you know your business overheads. What does it cost you to operate your business at a particular level of operation? To understand your business overhead costs, it will be necessary to prepare:


(a)Annual Budgets - detailing estimated cost of operation at various operational levels.

(b)Budgets for investments in stock and debtors so that the effect of operation at various levels on stock and debtors can be determined. For example, if your business only achieves a stockturn of 3 (this means that you only turnover stock three times per annum) and your average debtors balance is outstanding for 73 days, then you need to take this into account in planning what extra funds you are going to require to finance increasing sales to another operational level. It is dangerous to assume that your creditors will always allow you to extend your terms of credit. You may have to increase your bank overdraft or borrow additional funds. The interest and borrowing costs incurred need to be calculated so that they are included in your expense budgets.

(c)Cash Flow Forecasts. Once the operational budgets and stock and debtors budgets have been prepared, it is possible to prepare creditors budgets and then the cash flow forecast. If you are operating in overdraft the preparation of a cash flow forecast will enable the calculation of interest to be made so that this amount can be included in the expense budget. For further information, refer to Paper 05.35 - "Budget and Cash Flow Forecasts".

(d)Preparation of Periodic Accounting Reports (on a monthly basis) will greatly facilitate the comparison of actual costs incurred as compared to the budget to see whether costs have increased and therefore highlight whether there should be any adjustments made to selling prices. For further information, refer to Paper 05.50 - "Management Accounts (Monthly) Quarterly”.

(e)Preparation of revised business overhead cost lists. If the monthly financial statements indicate that operational costs are higher than what was originally budgeted, this will require the preparation of revised business overhead cost lists that are then utilised in the selling price calculations.

(f)Weekly Performance Calculations. Most businesses will benefit from the calculation of the business’s estimated profitability on a weekly basis. This will give an early indication as to whether the pricing strategies and cost estimates included in the budgets are realistic. For further information, refer to Paper 01.60 - "Weekly Performance Estimate Report".


10.Customers’ Perception On Prices

One aspect many business operators do not consider is the effect pricing has on customers’ perceptions. Since businesses rely on their customers for success, their customers perceptions towards a business and its products and services is extremely important. As a general rule, customers perceptions are as follows:
(a)High quality product sold at a high price - “premium goods”
(b)High quality product at a low price - “a superb value”
(c)A medium quality product at a high price - “over charging”
(d)A medium quality product at a low price - “good value”
(e)A low quality product at a low price - “cheap price”
(f)A low quality product at a high price - “a rip off”

There are obviously gray areas between these categories, but they give an indication of what customers expect and what they perceive in a business pricing policy. For further information, refer to Paper 18.01 - "Customer Service".


11. Mark Up/Gross Profit

You need to ask yourself some fundamental questions.

(a)What gross profit percentage do you expect to achieve from your business?

(b)How does this gross profit percentage compare with competitors in your industry?

(c)What is your sales mix? In other words, do you know what sales contributions each line of products that you are selling makes to your total sales figure?

(d)What are the individual gross profit percentages of the various products?

(e)What are the customers’ perception of your products?


12.Sales Statistics

Every business needs to understand key aspects of it’s sales statistics if it is going to be successful. These include:

(a)The business’s sales mix.
(b)Customers’ perceptions of the product or service that the business is offering.
(c)Sales being achieved per product and individual departmental sales.
(d)Sales being achieved per hour.
(e)Sales being achieved per employee.
(f)The gross profit being earned by individual employees on the sales made by him/her.