SKU Mentor and presenter Seth Werner, a senior lecturer a the marketing department at the Carlson School of Management at the University of Minnesota, is a national expert on pricing. He provided us with some key insights into how to determine pricing strategy.
Pricing is unique in that it is the one opportunity for the firm to capture value. Products and services, the places where they are sold and the ways that you promote them are all ways to create value, and these are costs. Pricing is revenue.
To get pricing right, start with the customer, not the accountant
Identify what product or services serve as your most relevant competition – what will the target customer do/buy if not your product? What is the next best competitive alternative (NBCA) from the customer’s point of view? Once you identify the NBCA you can identify the ways in which your offering is positively and negatively differentiated, again, from the customer’s point of view.
To the extent that your product is net negatively differentiated your product should be priced lower than the NBCA (next best competitive alternative). If your product is net positively differentiated, then you should be priced higher than the NBCA. Notice that pricing is dependent on the differentiated value that you create for the customer, not on your costs. If the value that you create is lower than your costs, you do not have a functional business model.
Right customer, right price
Price variation by retailer reveals the importance of appreciating a multi-tiered distribution system. When you sell into a retailer such as H-E-B, they are your customer, making the end user your customer’s customer. You need to pay attention to both. The challenge is that the value proposition that your product brings to each customer is likely different. H-E-B is looking at your product as a way to round out a shelf set – you are part of a portfolio of offerings. To the end user, you are likely the only product in that category that they will buy fulfilling a specific need. A category buyer at HEB is seeking to maximize profit, a busy parent is looking to get dinner on the table.
Price setting across retailers is largely a function of segmentation, retailers tend to serve different customers or, at least, customers at different need states. A shopper entering a 7-Eleven (seeking convenience) is likely different than a shopper entering Whole Foods (seeking natural/organic). Often price variation across channel is executed through packaging. A 7-Eleven offering is likely a single serve (lower shelf price point with a higher cost per ounce) while the Whole Foods offering is a multi-serve (higher shelf price with a lower cost per ounce). Further price variation of segments within a store can be accomplished through tools like coupons.
Paying for profits
Price changes are ‘asymmetrical’ – the unit volume you can afford to lose with a price increase is very different than the increase in unit volume needed to offset a price discount. For example, if you are working with a 30% contribution margin and you raise your price by 10%, you can lose 25% of your unit sales volume and maintain your profit before the price change. A price decrease of 10%, by contrast, will require a unit sales increase of 50%. It is critical to know the volume trade-offs you are making when changing your price – do the math.