Where you sit in the distribution chain and how long that chain is often influences how your pricing strategy is set.
There are probably just three ways you can price:
1. Cost plus: this is where you decide how much profit you want to make from a given product and you apply the margin to the cost.
2. Competitive pricing: this is where you check out your competitors and price against them, or just below.
3. Value pricing: this is where you look at your total proposition and charge a fair price for the service you provide.
Of course, you will probably say that you use a combination of 1 and 2. You calculate your margin to arrive at a price, then you sanity-check it against the competition and tweak it as necessary.
If you use a combination of all three, you can stop reading now and go back to counting your money, which must be a full time job for you. For those of you still with me, here are the strengths and weaknesses of each.
If you just use this system you will be flying blind in the market. You may well be successful, or even very successful, but you will never know if you could have made more profit, or if you could have sold more product. On the plus side you will definitely make your budgeted gross margin on your sales. Whether you will make and net profit will depend on your total sales value and your overheads.
If you use this system you will certainly know a lot about your customers and competitors, that is, assuming that your market intelligence is accurate. You will of course be aware of what a full-time job it is just to keep up with constantly changing pricing in the market. Your competitors continually discover your pricing structure, match or better it and you are back to square one, re-pricing again.
The up side is that you will often be competitive and will probably make good sales numbers, what a pity that the monthly accounts don’t look so healthy and the gross margin is down again and you’ll have to look at cutting costs to keep in front.
This pricing system takes account of both competition and cost, then applies it your business proposition. It takes account of all the advantages your business has over the competition and charges a premium, however modest, for this. Because it is carefully applied, it is justifiable, more than that, it’s a sales proposition that can be marketed to your customers as an advantage to them. The downside to this is that it requires some careful planning and enough conviction to make it work; other than that, it’s all positive, more sales at higher margins.
How does it work?
For example, lets assume that you are a wholesaler and you sit between the manufacturer and the retailer. The retailer could buy directly from the manufacturer, so why wouldn’t he?
– Space restriction for minimum order value
– Tight cash flow
– Lack of category knowledge
– Multiple suppliers needed to cover the category
A wholesaler can consolidate from different suppliers and supply little and often. To the retailer that means:
– Reduced inventory
– Improved cash flow
– Less administration (one account)
– Less sales people to see
– More time to spend with customers
Why wouldn’t he pay a premium for all that?
If you’re really good, you could provide category management for the customer, recommending which products to stock, how to display them and of course, how to price them! To do this properly, you have to be truly independent, know what you’re talking about and recommend what will sell, rather than what you make the most profit on.
The principles of value pricing can be applied to any business, but the key is to properly analyse your business and fully understand what your proposition really is. If you don’t have a clear proposition, it’s probably time you did!
By John Vaughan