Pricing has an immediate impact on your business -- positive or negative. That's why it's strategically important.
Unfortunately, common sense pricing is not always common in practice -- due sometimes to lack of knowledge of how to set prices, but much more frequently simply to bad assumptions based on the unquestioned acceptance of prevailing myths and rules-of-thumb. Pricing determines the profit of your business both directly -- as the result of revenues less costs -- and indirectly -- in its influence on stakeholder (customer, vendor, employee, investor, etc.) perceptions.
Amazon.com has a reputation of frugality that drives innovation that delivers low prices and ease of purchase to its customers....which eliminates the need for comparison shopping at brick and mortar book stores. For Borders and Barnes & Noble, the online competition is putting immense stress on their brick and mortar stores' business. After the dot-com bust, Borders transferred its online business to Amazon.com in 2001. Amazon operated a new Borders website, keeping all the revenue generated aside from a commission paid to Borders. Today, Amazon.com is recognized as more than an e-tailer of books and CDs--adding downloadable videos and MP3s plus selling other companies the Web services it uses to keep itself humming.
However, if you believe your customers' loyalty is to price alone, you are destined to wind up in a "How long can we go and still add margin dollars?" battle with your competitors. If your competitors are larger -- or better financed -- or better connected -- the odds are overwhelming that you'll lose.
In making volume pricing decisions, be very careful of over-reliance on your cost details. Most entrepreneurs' cost details represent best estimates (including cost reduction ideas) -- and exclude the extraordinary (never to happen again) mistakes that caused overtime and material waste on the last order. Be assured that the highest percentage of credit problems, schedule changes and other cost impairments will come from your discounted high volume deals.
Every business must receive an adequate gross profit from each sale to pay for corporate overhead, reasonable wages and the selling expense of telling the market the value of its products and services. If fact, you must be willing to risk losing orders (regardless of their perceived importance) if the sales revenue can not be obtained at prices that yield a reasonable gross profit.
The good news is that most people believe that "price is a reflection of quality."
In a study published online, earlier this year in the Proceedings of the National Academy of Sciences, students at the Stanford Graduate School of Business and the California Institute of Technology were placed in an MRI machine and given sips of red wine--including the same one presented twice, with two different price tags: $5 (the actual bottle price) and $45 (a fictional price).
The subjects all said they liked the "expensive" wine better--a preference mirrored by increased activity in their prefrontal cortexes. When people know a wine is expensive, the pleasure they get from it is enhanced in the area of the brain where such sensations are processed.
The lesson, says Baba Shiv, an associate professor of marketing at Stanford: "There's a temptation among marketers to keep reducing prices. We're saying be careful before you embark on that strategy."
Believing that lack of profit results only from higher costs fails to recognize the importance of setting and maintaining adequate profit margin pricing. And if maintaining adequate margin pricing causes you to walk away from some business opportunities, so be it. The business that you lose due to high prices is the business you can't afford to maintain.
Source: BusinessWeek, April 28, 2008