In this post, I talk about the importance of having a winning pricing strategy & how to do pricing of products effectively when you are planning your business or product category. I will explain this through examples of different pricing strategies and my learning experiences in managing product categories.
Why is a winning pricing strategy important?
A pricing strategy is a way through which one achieves the revenue, margin & market share objectives of the company. The way you price your products or services reflects the business’s identity, how you view and treat your competitors and how you value your customers. That’s why it’s important to have a carefully planned pricing strategy.
How to decide the price?
Here, I will be talking about the first pricing strategy which is the Cost-plus price strategy.
Cost-Plus Pricing is a pricing method in which the selling price is set by evaluating all variable costs a company incurs and adding a markup percentage to establish the price. So, the price will be set as:
Price = Cost + Profit Margin
Cost is something that comes after factoring in the product’s manufacturing cost, freight, customs duty, distribution expenses, marketing expenses & other miscellaneous costs.
How much margin can you keep?
If you’re pricing for a category that is highly competitive with multiple players & no significant differentiation In the products, chances are your margins would be lower. An example is commodity products like groceries, staples, or metals where there is no value addition.
However, if the competition is low and there is considerable value differentiation in your product you can drive higher margins.
Let me take an example from the computer accessories category which I was managing at work. Since the branded organized market has lower competition and because Lenovo’s products were differentiated and of superior quality, we were able to drive a higher margin.
The cost-plus pricing strategy is mostly used for physical products from manufacturing companies where there is a relatively predictable fixed cost (such as raw material, labour, maintenances, shipping etc), it is easy to assign a profit margin percentage using markup pricing on top that sustains the business.
This strategy is fast to implement and easy to calculate, however, it lacks connection with the value your product provides to customers & it also makes it difficult to change prices when necessary.
This brings me to the second pricing strategy:
Competitor Based Pricing Strategy
In this type of pricing strategy, a category or product manager maps the products as per the competitor products’ pricing.
Have you noticed that you pay roughly the same amount for Netflix, Amazon Prime Video, Disney+ and other streaming services? That’s because these companies have adopted competitive pricing.
For a new player who wants to establish a foothold in the market, this type of pricing strategy is ideal. This gives us the current pricing structure running in the market. If the new company also has equivalent features or even superior product features, following this pricing strategy helps get a share of the market early as a similar product already exists in the market. If you’re in a competitive market, pricing for the companies involved should be close to what the market can reasonably sustain.
This is true for already existing/established businesses as well, who are required to offer equivalent prices as per competition for similar features products to maintain their market share. But the biggest downside of competitor-based pricing is that you are not using your pricing strategy but following the competitors’ pricing strategy.
Ways to overcome this challenge:
A company or product the company exists to offer customers something different to what is already on the market. A category or product manager should always strive for: Can they offer more value to customers and get a higher profit on their products?
This is a constant process where you as a product manager need to constantly work on improving and bringing differentiating features from your competitors. If those features are unique it may provide stickiness to your customers – then they will stick with your product as well as will pay you more.
Let me share an example of a product that is called a docking station or a multi-port hub. This product is used to connect multiple accessories to a laptop-like a keyboard, mouse, extra display, printer, charge your laptop and so on. Since it is a Universal product every big OEM like Lenovo, HP, Dell, and Targus would have their own docking station. What Lenovo, where I work, did is – we brought a Universal dock that had the latest ports and had free software bundled in it to allow automatic firmware upgrade whenever Lenovo would launch a new version of the software upgrade. Also, the software helped to manage all the devices connected to docks.
In this way – companies can offer better value for similar product features and can increase their margins. Also always communicate the benefits of the product to the customers and not the product features. The benefits are how your product is going to help the users – like this dock will increase the productivity of users because this dock expands the potential of the user’s laptop device by giving them the option to connect with multiple displays and peripherals.
The second way to overcome this margin challenge is by creating a superior brand value. Let me give an example from Paints Industry where there are multiple players in the Indian market and competition is also quite tough. Amidst all these, a company like Asian Paints has been able to create a superior brand value through its multiple brands, unique marketing, strong distribution network and channel-centric policies. Not only this superior brand value helps retain higher margins but also helps to pass down the prices in case of any input cost increase.
Penetration Pricing / Aggressive Price Strategy
Penetration pricing is an acquisition strategy for companies that are trying to gain a foothold in highly competitive markets. These companies “penetrate” the market by offering a lower price than their competitors—enticing customers away from their current provider to gain market share.
In this type of Price strategy, you take over a market by undercutting your competitors. Once you develop a reliable customer base, then you try to raise prices. Many factors go into deciding on this strategy, like your business’s ability to potentially take losses upfront to establish a strong footing in a market.
Penetration pricing is a popular tactic in the business-to-consumer (B2C) market. The competitive nature of these products and the number of choices most consumers have made it difficult to gain a footing in a new market without a strong acquisition strategy.
For example – Reliance Jio – a telecom service provider launched its telecom services few years ago in India and penetrated the market with an aggressive price strategy. It offered free data and voice connections to users and charged a fixed monthly subscription fee. As all these services were offered at a cheaper price, customers switched to Reliance Jio. If Reliance Jio had priced itself closer to AIRTEL as the biggest service provider at the time of launch, it would not have been able to build its customer base as faster.
When you’re deciding whether to implement a penetration pricing strategy, it’s important to understand when it can help your company and when it can hurt it. Entering markets quickly can be very enticing but will require more work to maintain your place once it’s time to increase the price.
Value-Based Pricing Strategy / Customer-Based Pricing
This brings me to the last pricing strategy which is Value-Based Pricing or customer-based pricing.
It is mostly used for B2B companies where there is a customer-specific product or service is sold. It is used commonly for software products, cloud-based products & services.
What is the value-based pricing strategy?
Value-based pricing is a strategy that defines the price of a product or service based on what the target customer believes it is worth. It involves offering a unique value to customers, based on what they need and basing your prices on how the customer perceives the value of your product or service. Rather than looking at competitors or the market or the cost of the product, you go directly to the source, the customer, and choose a price based on what they’re willing to pay.
For example, in IT Services Industry for a software project, pricing is done basis the requirements of the client, the timeline of the project, the level of expertise required to execute the project and the number of resources required. Considering all these factors, the pricing for one client may differ from the other. Hence the pricing is based on the value that the customer is deriving and willing to pay.
Value-based pricing strategy can also be used in a product company that is selling services or software with their products. For example, a computer manufacturing company sells laptops to their B2B clients which further is to be used by their employees, the company can also upsell a lot of services & software like service of managing all the assets, 24*7 support services to reduce downtime of employees’ devices, remote device management software, endpoint security solution software to prevent malware attack on user’s laptop. By offering these value-based products/services which are unique and differentiated, a product company can price these products & services basis the value it gives to customers instead of a fixed price that is not derived from the product’s cost.
How is value-based pricing calculated?
To calculate prices using the value-based method, one needs to deeply study the customer profiles/segments or existing data on your customer base, as well as talk to customers about how much they value your product. You can use this data to create different price points based on different profiles and customer segments and the variations in what these segments are willing to pay. It also gives you unique flexibility in finding and implementing price points that suit different types of customers.
Why is value-based pricing important?
Value-based pricing is important because it involves looking outside to the customer, rather than basing prices on things like cost or competitors. This ensures you’re not restricted to basing your pricing on existing pricing structures or on achieving minimal profitability, but instead on a customer’s willingness to pay.
Also knowing what your customers value always will make evolving your product and features an absolute must. Finally, since your customers are determining product value, you need to communicate with them quite a bit. This constant communication builds great company & customer rapport. You’re building trust and this trust can lead to good things down the road, like higher retention and less churn.
However, figuring out customer valuations is more difficult than it sounds, which is why so many companies opt for cost-plus and competitor-based pricing.
Summary
Too many businesses set their pricing without putting much thought into it. On the contrary, getting product pricing right can act as a powerful growth lever. If you optimize your pricing strategy so that more people are paying a higher amount, you’ll end up with significantly more revenue than a business that treats pricing more passively. This sounds obvious, but it’s rare for businesses to put much effort into finding the best pricing strategy.
If you’ve already launched your business, you can experiment with these strategies until you determine what works best for your business. You can also vary strategies between products depending on the market for each good or service. For example, even in the same product category where you have a cost-plus strategy to achieve a certain profit, you can choose to have a few products which are more aggressively priced than the competition to gain a higher share of those products. In this way, you are having a hybrid strategy that is optimizing your profits and at the same time allowing you to gain more market share and thus helping you to increase the revenue.
Thoughts on Product Management 