Pricing (Encyclopedia of Business and Finance)
Price is perhaps the most important of the four Ps of marketing, since it is the only one that generates revenue for a company. Price is most simply described as the amount of money that is paid for a product or service. When establishing a price for a product or service, a company must first assess several factors regarding its potential impact. Commonly reviewed factors include legal and regulatory guidelines, pricing objectives, pricing strategies, and options for increasing sales.
LEGAL AND REGULATORY GUIDELINES
The first major law influencing the price of a company's product was the Sherman Antitrust Act of 1890, passed by Congress to prevent a company from becoming a monopoly. A monopoly occurs when one company has total control in the production and distribution of a product or service. As a monopoly, a company can charge higher than normal prices for its product or service, since no significant competition exists. The Sherman Antitrust Act empowers the U.S. Attorney General's Office to challenge a perceived monopoly and to petition the federal courts to break up a company in order to promote competition. An example of the successful use of Sherman Antitrust Act regulations occurred when the Attorney General's Office used them to break up the telephone giant, AT&T, in the 1980s. As a result of AT&T's breakup, several new telephone companies, such as MCI and Sprint, were created. The formation of these and other new phone companies during the 1980s resulted in the more competitive pricing of telephone services.
Another significant piece of legislation that has a major effect on determining price is the Clayton Act of 1914, passed by Congress in order to prevent practices such as price discrimination and the exclusive or nearly exclusive dealing between and among only a few companies. Like the Sherman Antitrust Act, this act prevented practices that would reduce competition. The Robinson-Patman Act of 1936, which is technically an extension of the Clayton Act, further prohibits a company from selling its product at an unreasonably low price in order to eliminate its competitors. The purpose of this act was to prohibit national chain stores from unfairly using volume discounts to drive smaller firms out of business. To defend against charges of violating the Robinson-Patman Act, a company would have to prove that price differentials were based on the competitive free market, not an attempt to reduce or eliminate competition. Because regulations of the Robinson-Patman Act do not apply to exported products, a company can offer products for sale at significantly lower prices in foreign markets than in U.S. markets.
Another set of laws influencing the price of a company's product are referred to as the unfair trade laws. Passed in the 1930s, these laws were designed to protect special markets, such as the dairy industry, and their main focus is to set minimum retail prices for a product (e.g., milk), allowing for a slight markup. Theoretically, these laws would protect a specialty business from larger businesses that could sell the same products below cost and drive smaller, specialty stores out of business. Fair trade laws are a different set of statutes that were enacted by many state legislatures in the early 1930s. These laws allow a producer to set a minimum price for its product; hence, retailers signing pricing agreements with manufacturers are required to list the minimum price for which a product can be sold. These acts prevent the use of interstate pricing agreements between manufactures and retailers, grounded in the belief that this would promote more competition and, as a result, lower prices. An important aspect of these acts is that it does not apply to intrastate product prices.
A critical part of a company's overall strategic planning includes the establishment of pricing objectives for the products it sells. A company has several pricing objectives from which to choose, and the objective chosen will depend on the goals and type of product sold by a company. The four most commonly adopted pricing objectives are (1) competitive, (2) prestige, (3) profitability, and (4) volume pricing.
Competitive Pricing The concept behind this frequently used pricing objective is to simply match the price established by an industry leader for a particular product. Since price difference is minimized with this strategy, a company focuses its efforts on other ways to attract new customers. Some examples of what a company might do in order to obtain new customers include producing high-quality and reliable products, providing superior customer service, and/or engaging in creative marketing.
Prestige Pricing A company may chose to promote, maintain, and enhance the image of its product through the use prestige pricing, which involves pricing a product high so as to limit its availability to the higher-end consumer. This limited availability enhances the product's image, causing it to be viewed as prestigious. Although a company that uses this strategy expects to have limited sales, this is not a problem because a profit is still possible due to the higher markup on each item. Examples of companies that use prestige pricing are Mercedes-Benz and Rolls Royce.
Profitability Pricing The basic idea behind profitability pricing is to maximize profit. The basic formula for this objective is that profits equal revenue minus expenses (P = R - E). Revenue is determined by a product's selling price and the number of units sold. A company must be careful not to increase the price of the product too much, or the quantity sold will be reduced and total profits may be lower than desired. Therefore, a company is always monitoring the price of its products in order to make sure it is competitive while at the same time providing for an acceptable profit margin.
Volume Pricing When a company uses a volume-pricing objective, it is seeking sales maximization within predetermined profit guidelines. A company using this objective prices a product lower than normal but expects to make up the difference with a higher sales volume. Volume pricing can be beneficial to a company because its products are being purchased on a large scale, and large-scale product distribution helps to reinforce a company's name as well as to increase its customer loyalty. A subset of volume pricing is the market-share objective, the purpose of which is to obtain a specific percentage of sales for a given product. A company can determine an acceptable profit margin by obtaining a specific percentage of the market with a specific price for a product.
Companies can chose from a variety of pricing strategies, some of the most common being penetration, skimming, and competitive strategies. While each strategy is designed to achieve a different goal, each contributes to a company's ability to earn a profit.
Penetration Pricing Strategy A company that wants to build market share quickly and obtain profits from repeat sales generally selects the penetration pricing strategy, which can be very effective when used correctly. For example, a company may provide consumers with free samples of a product and then offer the product at a slightly reduced price. Alternatively, a company may initially offer significant discounts and then slowly remove the discounts until the full price of the product is listed. Both options allow a company to introduce a new product and to start building customer loyalty and appreciation for it. The idea is that once consumers are familiar with and satisfied with a new product, they will begin to purchase the product on a regular basis at the normal retail price.
Price Skimming Strategy A price-skimming strategy uses different pricing phases over time to generate profits. In the first phase, a company launches the product and targets customers who are more willing to pay the item's high retail price. The profit margin during this phase is extremely high and obviously generates the highest revenue for the company. Since a company realizes that only a small percentage of the market was penetrated in the first phase, it will price the product lower in the second phase. This second phase pricing will appeal to a broader cross-section of customers, resulting in increased product sales. When sales start to level off during this phase, the company will price the product even lower. This third-phase pricing should appeal to those consumers who were price-sensitive in the first two phases and result in increased sales. The company should now have covered the majority of the market that is willing to purchase its product at the high, medium, and low price ranges. The price-skimming strategy provides an excellent opportunity for the company to maximize profits from the beginning and only slowly lower the price when needed because of reduced sales. Price adjustment with this strategy closely follows the product life cycle, that is, how customers accept a new product. Price skimming is a frequently used strategy when maximum revenue is needed to pay off high research and development costs associated with some products.
Competitive Pricing Strategy Competitive pricing is yet another major strategy. A company's competitors may either increase or decrease their prices, depending upon their own objectives. Before a company responds to a competitor's price change with one of its own, a thorough analysis as to why the change occurred needs to be conducted. An investigation of price increases or decreases will usually result in one or more of the following reasons for the change: a rise in the price of raw materials, higher labor costs, increasing tax rates, or rising inflation. To maintain an acceptable profit margin for a particular product, a company will usually increase the price. In addition, strong consumer demand for a particular product may cause a shortage and, therefore, allow a company to increase its price without hurting either demand or profit.
When a competitor increases its price, a company has several options from which to chose. The first is to increase its price to approximately the same as that of the competing firm. The second is to wait before raising its price, a strategy known as price shadowing. Price shadowing allows the company to attract new customershose who are price-sensitiveaway from the competing firm. If consumers do switch over in large numbers, a company will make up lost profits through higher sales volume. If consumers do not switch over after a period of time, the company can increase its price. Typically, a company will increase its price to a level slightly below that of its competitors in order to maintain a lower-price tactical advantage. The airline industry uses the competitive pricing strategy frequently.
When competitors decrease their prices, a company has numerous options. The first option is to maintain its price, since the company is confident that consumers are loyal and value its unique product qualities. Depending on the price sensitivity of customers in a given market, this might not be an appropriate strategy for a company to use. The second is to analyze why a competitor might have decreased its prices. If price decreases are due to a technological innovation, then a price decrease will probably be necessary because the competitor's price reduction is likely to be permanent. Regardless of its competitor's actions, a company may decrease its price. This price reduction option is called price covering. This option is most useful when a company has done a good job of differentiating the qualities of its product from those of a competitor's product. On the flip side, the advantage of price covering is reduced when no noticeable difference can be seen between a company's product and that of a competitor.
OPTIONS FOR INCREASING SALES
Companies have several options available when attempting to increase the sales of a product, including coupons, prepayment, price shading, seasonal pricing, term pricing, segment pricing, and volume discounts.
Coupons Almost all companies offer product coupons, reflecting their numerous advantages. First, a company might want to introduce a new product, enhance its market share, increase sales on a mature product, or revive an old product. Second, coupons can be used to generate new customers by getting customers to buy and try a company's productn the hope that these trial purchases will result in repeat purchases. A variety of coupon distribution methods are available, such as Sunday newspapers and point-of-purchase dispensers.
Prepayment A prepayment plan is typically used with customers who have no or a poor credit history. This prepayment method does not generally provide customers with a price break. There are, however, prepayment methods that do reduce the price of a product. For example, the prepayment strategy is widely used in the magazine industry. A customer who agrees to purchase a magazine subscription for an extended period of time normally receives a discount as compared to the newsstand price. Purchase of gift certificates is another example of how prepayment can be used to promote sales. For example, a company may offer discounts on a gift certificate whereby the purchaser may only pay 90 to 95 percent of the gift certificate's face value. There are several advantages of using this strategy. First, consumers are encouraged to buy from the company offering the gift certificates rather than from other stores. Second, the revenue is available to a company for reinvestment prior to the product's sale. Finally, receivers will not redeem all gift certificates, and as a result, a company retains all the revenue.
Price Shading One way to increase company sales is to allow salespeople to offer discounts on the product's price. This tactic, known as price shading, is normally used with aggressive buyers in industrial markets who purchase a product on a regular basis and in large volumes. Price shading allows salespeople to offer more favorable terms to preferred industrial buyers in order to encourage repeat sales.
Seasonal Pricing The price for a product can also be adjusted based on seasonal demands. Seasonal pricing will help move products when they are least saleable, such as air conditioners in the winter and snow blowers in the spring. An advantage of seasonal pricing is that the price for a product is set high during periods of high demand and lowered as seasonal demand drops off to clear inventory to make room for the current season's products.
Term Pricing A company has another positive reinforcement strategy for use when establishing product price. For example, a company may offer a discount if the customer pays for the product promptly. The definition of promptly varies depending on company policy, but normally it means the account balance is to be paid in full within a specific period of time; in return, a company may provide a discount to encourage continuation of this early payment behavior by the customer. This term pricing strategy is normally used with large retail or industrial buyers, not with the general public. Occasionally, a company will offer a small discount to customers who pay for a product with cash.
Segment Pricing Segment pricing is another tactic a company can use to modify product price in order to increase sales. Everyday examples of segment pricing discounts are those extended to children, senior citizen, and students. These discounts have several positive benefits. First, the company is appearing to help those individuals who are or are perceived to be economically disadvantaged, a perception that helps create a positive public relations image for a company. Second, members of those groups who ordinarily may not purchase the product are encouraged to do so. Therefore, a company's sales will increase, which will likely result in increased market share and revenue.
Volume Discounts A common method used by a company to price a product is volume discounting. The idea behind this pricing strategy is simplef a customer purchases a large volume of a product, the product is offered at a lower price. This tactic allows a company to sell large quantities of its product at an acceptable profit margin. Volume pricing is also useful for building customer loyalty.
Price is an important component of the four Ps of marketing because it generates revenue. Price is often thought of as the money that this paid for a product or service. Several factors need to be examined when setting a product price. Frequently reviewed factors include legal and regulatory guidelines, pricing objectives, pricing strategies, and options for increasing sales, since all of these factors contribute to the price established for a product.
Boone, L. E., and Kurtz, D. L. (1992). Contemporary Marketing, 7th ed. New York: Dryden/Harcourt Brace.
Churchill, G. A., and Peter, J. P. (1998). Marketing: Creating Value for Customers, 2d ed. Boston: Irwin/Mcgraw-Hill.
Farese, L., Kimbrell, G., and Woloszyk, C. (1995). Marketing Essentials. Mission Hills, CA: Glencoe/McGraw-Hill.
Kotler, P., and Armstrong, G. (1998). Principles of Marketing, 8th ed. Englewood Cliffs, NJ: Prentice-Hall.
Semenik, R. J., and Bamossy, G. J. (1995). Principles of Marketing: A Global Perspective, 2nd ed. Cincinnati, OH: South-Western.
Pricing (Encyclopedia of Small Business)
Intelligent pricing is one of the most important elements of any successful business venture. Yet many entrepreneurs fail to educate themselves adequately about various pricing components and strategies before launching a new business. Smart small business owners will weigh many marketplace factors before setting prices for their goods and services. As the Small Business Administration (SBA) indicated in The Facts About Pricing Your Products and Services, "you must understand your market, distribution costs, and competition. Remember, the marketplace responds rapidly to technological advances and international competition. You must keep abreast of the factors that affect pricing and be ready to adjust quickly."
COST FACTORS AND PRICING
There are three primary cost factors that need to be considered by small businesses when determining the prices that they charge for their goods or services. After all, price alone means little if it is not figured within the context of operating costs. A company may be able to command a hefty price for an item, only to find that the various costs of producing and delivering that item eliminate most or all of the profit that it realizes on the sale. It should also be noted that service businesses often find it more difficult to accurately gauge their costs, especially in the realm of employee hours. A freelance copyeditor may find that one 2,500-word article takes twice as long to complete as another article of the same size because of differences in quality that are often difficult to anticipate ahead of time.
LABOR COSTS Labor costs consist of the cost of the work that goes into the manufacturing of a product or the execution of a service. Direct labor costs can be figured by multiplying the cost of labor per hour by the number of employee-hours required to complete the job. Business owners, however, need to keep in mind that the "cost of labor per hour" includes not only hourly wage or salary of the relevant employees, but also the costs of the fringe benefits that those workers receive. These fringe benefits can include social security, retirement benefits, insurance, unemployment compensation, workers compensation, and other benefits.
MATERIAL COSTS Material costs are the costs of all materials that are part of the final product offered by the business. As with labor, this expense can apply to both goods and services. In the case of goods, material costs refer to the costs of the various components that make up a product, while material costs associated with services rendered typically include replacement parts, building parts, etc. A deck builder, for example, would include such items as lumber, nails, and sealer as material costs.
OVERHEAD COSTS Overhead costs are costs that cannot be directly attributed to one particular product or service. Some business consultants simply refer to overhead costs as those business expenses that do not qualify as labor costs or material costs. These costs include indirect expenses such as general supplies, heating and lighting expenditures, depreciation, taxes, advertising, rental or leasing costs, transportation, employee discounts, damaged merchandise, business memberships, and insurance. A certain percentage of employees usually fit in this category as well. While the wages and benefits received by an assembly line worker involved in the production of a specific product might well qualify as a labor cost, the wages and benefits accrued by general support personnelanitors, attorneys, accountants, clerks, human resource personnel, receptionistsre included as overhead.
Overhead expenses are typically divided into two categoriesixed expenses and variable expenses. Fixed expenses are regular (usually monthly) expenses that will not change much, regardless of a company's business fortunes. Examples of fixed expenses include rent, utilities, insurance, membership dues, subscriptions, accounting costs, and depreciation on fixed assets. Variable expenses are those expenses that undergo greater fluctuation, depending on variables such as time of year (for seasonal businesses), competitor advertising, and sales. Expenses that are more heavily predicated on company revenues and business owner strategies include office supplies, mailing and advertising, communications (telephone and Fax bills), and employee bonuses.
COST OF GOODS SOLD One of the most important tools that accountants and entrepreneurs use to gauge the health of businesses is the "cost of goods sold." This figure is in essence the business's total cost of manufacturing the products it sells orn the case of retail firmsts total expenditures to purchase products for resale. Delivery and freight charges are typically included within this equation. Cost of goods sold provides business owners with a rough measurement of their gross profit margin. The figure usually bears a close relationship to sales, but it may vary significantly if increases in the prices paid for merchandise cannot be offset by increases in sales prices, or if profit margins swell because of special purchase deals or sudden surges in product popularity.
Small businesses have many different pricing strategies from which they can choose, but they need to select carefully. An ill-considered decision can place a heavy burden on the business.
MANUFACTURER'S SUGGESTED RETAIL PRICE Many small businesses prefer to simply price their goods in accordance with the manufacturer's suggested retail price. They thus eliminate costs associated with making their own pricing decisions or pursuing more proactive pricing strategies. Critics note, however, that this strategyuch as it iss utterly heedless of the competition, which may be able to offer a lower price for any number of reasons.
PRICE BUNDLING This is the practice of giving the customers the option of buying several items or services for one price. A furniture retailer, for example, might offer customers a sofa and love seat combination at a price that is somewhat lower than what the two goods would cost if bought separately. Similarly, a landscaper might lure customers by offering two free months of lawn maintenance with any major landscaping job. Leonard Berry and Manjit Yadav noted in Sloan Management Review that bundling has several advantages, especially for service-oriented businesses: "The cost structure of most service companies is such that providing an additional service costs less than providing the second service alone A second benefit of bundling that appeals to customers is purchasing related services from one service provider. They can save time and money by interacting with an paying one provider rather than multiple providers. Third, bundling effectively increases the number of connections a service company has with its customers."
MULTIPLE PRICING Similar to price bundling, multiple pricing is the practice of selling multiple units of an item for a single price. A grocery store that offers two boxes of macaroni and cheese at a single price, for instance, is engaged in multiple pricing. Whereas price bundling is more commonly employed for big-ticket items, multiple pricing is usually used to sell inexpensive consumable items such as razor blades, shampoo, household cleaning products, and food and beverages.
COST-PLUS PRICING This methodology, popular with manufacturers, involves adding together all labor, material, and overhead costs (the "cost") and then adding the desired profit (the "plus").
COMPETITIVE PRICING Some small business owners choose to base their own prices on the prices of their principal competitors. Business owners who choose to follow this course, however, should make sure that they look at competing businesses of similar size and strength. "It's very chancy to compete with a large store's prices," noted the SBA's The Facts About Pricing Your Products and Services, "because they can buy in larger volume and their cost per unit will be less. Instead, price products based on your local small-store analysis, then highlight other competitive factors, like personalized customer service and convenient location." Competitive pricing among service-oriented businesses, meanwhile, is a hazier proposition, since the nature and quality of services offered can vary so widely from business to business. Still, it is often employed, if only as a general pricing guideline.
PRICING ABOVE COMPETITION If a business is operating in a community in which low prices are most customers' primary concern, then this pricing strategy is obviously doomed to failure. In settings in which price is not the customer's most important consideration, however, some small businesses can do quite well employing this strategy. The key to making "pricing above competition" work, say experts, is to provide customers with added benefits that justify paying the higher price. These benefits can take the form of: 1) convenient or exclusive location; 2) social status; 3) exclusive merchandise; and 4) high level of service. The latter can take the form of home or office delivery of goods, service and/or product knowledge, speed of service, attractive return policies, and friendly atmosphere.
Some business owners also boost prices in markets that have few competitors, reasoning that the community has little choice but to buy from their businesses. Such prices rarely reach outrageous levels, but they can become sufficiently high that enterprising entrepreneurs will recognize an opportunity to undercut the business with more inexpensively priced goods or services.
PRICING BELOW COMPETITION Pricing below competition is the practice of setting one's prices below those of its competitors. Commonly employed by major discount chains such as Wal-Marthich can do so because its purchasing power enables it to save on its costs per unithis strategy can also be effectively used by smaller businesses in some instances (though not when competing directly with Wal-Mart and its ilk), provided they keep their operating costs down and do not spark a price war. Indeed, the smaller profit margins associated with this pricing strategy make it a practical necessity for participating companies to: exercise tight control over inventory; keep labor costs down; keep major operational expenses such as facility leases and equipment rental under control; obtain good prices from suppliers; and make effective use of its pricing strategy in all advertising.
PRICE LINING Companies that engage in this practice are basically hoping to attract a specific segment of the community by only carrying products within a specified price range. This strategy is often employed by businesses whose goods/services or location are likely to attract upscale buyers, though others use it as well. Advantages sometimes accrued through price lining practices include: reduced inventory and storage costs, ease of merchandise selection, and enhanced status. Analysts note, however, that this strategy frequently limits the company's freedom to react to competitors' pricing strategies, and that it can leave businesses particularly vulnerable to economic trends.
ODD PRICING Odd pricing is used in nearly all segments of the business world today. It is the practice of pricing goods and services at prices such as $9.95 (rather than $10) or $79.99 (rather than $80) because of the conviction that consumers will often round the price down rather than up when weighing whether to make a purchase. This little morsel of pricing psychology has become so universally employed that many observers question its value; still, the practice remains widespread across the United States (and elsewhere).
Other commonly used pricing policies include penetration pricing and skimming pricing (for manufacturers) and loss leader pricing (for retailers).
FACTORS IN ARRIVING AT A PRICING STRATEGY
Entrepreneurs encounter numerous considerations that should be weighed when assigning a price to their goods or services. These considerations range from the needs and desires of target consumers to general economic conditions. The SBA cited the following factors as among the most important to consider when arriving at a pricing strategy.
- Is the price of the good or service of significant importance to target consumers?
- How popular is the product or service being offered?
- What pricing and marketing strategies are compatible with the business's other characteristics (location, service reputation, promotions, etc.)
- Does the owner enjoy final pricing authority?
- Are there opportunities for special market promotions?
- What are competitors charging for similar goods or services?
- Should competitors' temporary price reductions be matched?
- What level of markup can be achieved for each product line or area of service?
- Will prices generate a satisfactory profit margin after calculating operating expenses and reductions?
- When reducing prices on goods or services, do you consider competitors' likely reactions?
- Are there legal factors to consider when establishing price?
- Should "odd pricing" or "multiple pricing" practices be introduced?
- Should marketing efforts highlight sales of selected high-profile products to attract customers?
- If coupons and other discount measures are offered, how will they impact on net profits?
- Will characteristics of the product sold (handling costs, installation requirements, alterations, etc.) meaningfully add to operating costs?
- Will product quantities be unduly reduced as a result of spoilage, breakage, employee theft, or shoplifting?
- Will services such as home/office delivery, gift wrapping, etc. be included in the purchase price?
- Are economic conditions in area of operation particularly good or bad?
- Will employees receive discounts on store items that they purchase?
- Will senior citizens or students receive discounts on goods or services?
- What markdown policies are in place?
REVISITING PRICING STRATEGIES
Since pricing is one of the single most important factors in determining whether a business will be successful, small business owners should continuously review their pricing policies to make certain that they remain in keeping with marketplace realities. Business environments can change quickly, and the successful entrepreneur will learn to change his or her pricing strategies accordingly. William Cohen, author of The Entrepreneur and Small-Business Problem Solver, described six different circumstances in which small business owners should review their pricing and make changes if necessary: 1) when introducing a new product or product line; 2) when testing for the best price; 3) when attempting to break into a new market;4) when competitors change their prices; 5) when general economic conditions become inflationary or recessionary; 6) when weighing major changes in sales strategy. Indeed, any significant change in any aspect of a business's operationsrom rising costs of raw materials to changing insurance premiumshould spark a review of company pricing strategies.
REAL PRICE AND NOMINAL PRICE
Economists, business owners, and other people engaged in the world of commerce have long recognized that historical events can help business owners evaluate current business plans and propose future strategies, including pricing strategies. Indeed, as Robert Pindyck and Daniel Rubinfeld observed in Microeconomics, "we often want to compare the price of a good today with what it was in the past or is likely to be in the future." Such comparisons are meaningless, however, unless those prices are measured "relative to the overall price level. In absolute terms, the price of a dozen eggs is many times higher today than it was 50 years ago, but relative to prices overall, it is actually lower. Therefore, we must be careful to correct for inflation when comparing prices across time. This means measuring prices in real rather than nominal terms." Pindyck and Rubinfeld go on to define the nominal price of a good (its "current dollar" price) as its absolute price, noting that the nominal price of a quart of milk was 40 cents in 1970 and about 80 cents in 1990. The real price, however, is defined as the price relative to an aggregate measure of prices (usually the Consumer Price Index-CPI). Percentage changes in the CPI measure the rate of inflation in the economy.
Small business owners are often reluctant to raise prices once a good baseline price has been established. They worry that a price increase will alienate customers and drive them to the competition. "Faced with such resistance, a lot of businesspeople are tempted to forgo price increases altogether, or at least put them off for as long as possible. If you do either one, however, you're making a big mistake," Norm Brodsky wrote in Inc. "Your profit margins will be shrinking You're gradually undermining the perceived value of your services or products." Brodsky noted that many of a small business's costsuch as payroll, insurance, and utilitiesend to rise every year, slowly cutting into profit margins. In addition, customers tend to associate price with quality. A business that does not increase prices to keep up with the competition risks being regarded as the cheap alternative in the marketplace.
When price increases are implemented gradually and cautiously, small businesses may be able to keep their customers happy while also keeping their profit margins intact. After all, as Harry J. Plack wrote in the Baltimore Business Journal, customers typically base their purchase decisions on more than just price. Other factors influencing the decision process include quality, features, guarantees, and personal desires. In addition, people will always pay more for good, reliable customer service. In order to make an effective price increase, Howard Scott of Nation's Business recommended conveying the reasons for the increase to customers and giving them a perceived increase in value for their money. "The message for companies is clear," Scott wrote. "Those that differentiate their products from the competition's and are able to articulate that difference to customers are more likely to be able to raise pricesnd keep them raisedbove the competition's."
SURVIVING COMPETITORS' DISCOUNT PRICING STRATEGIES
Major discount stores such as Wal-Mart, Sam's Club, Target, K-Mart, Office Depot, Staples, Best Buy, and Circuit City have gained control of large blocs of the American business world over the last several years on the strength of their one-stop shopping and discount prices, the latter a result of their ability to buy goods at bulk rates. Many small business owners have felt the impact of these storesndeed, cautionary tales concerning the impact that such stores can have on formerly vibrant downtown shopping areas have proliferated in recent years.
Many observers believe, however, that some small business failures that occurred in the wake of these titans' arrivals could have been avoided if small business owners had adopted different strategies to deal with the new competitive environment in which they were operating. Indeed, economists and business analysts agree that most small businesses cannot compete with large chains in the area of price; the bulk-rate buying power advantage that the big stores enjoy is simply too great to overcome. But they contend that many small businesses can still co-exist with these titans if their owners outmaneuver the big stores in other areas. Effective strategies that can be used to help negate the discount pricing strategy employed at the big chains include:
- Emphasize value and personal service rather than price
- Offer attractive ancillary services (home and office delivery, generous return policies, etc.)
- Define your market segment or niche and devote energies accordingly
- Control inventory
- Streamline to eliminate less profitable areas of business
- Target advertising and promotions to reach the most likely customers
- Steer customers to the most profitable aspects of your business
- Establish your business's industry knowledge as an additional resource for customers
- Build strong relationships with vendors
- Meet or beat prices of big discounters on selected lead items or services
- Make intelligent use of price strategies such as price bundling.
Of course, pricing remains a very big component in determining a company's success or failure. "The key to success," concluded the SBA in its Pricing Your Products brochure, "is to have a well-planned strategy and established policies and to constantly monitor prices and operating costs to ensure a profit." Finally, the SBA cautioned entrepreneurs to "remember that the image of your business is crucial to obtaining and keeping the clientele and that your pricing structure and policies are a major component of your image."
Brodsky, Norm. "Street Smarts: Raising Prices." Inc. May 2000.
"Case Study: How to Price Your Products to Increase Profits." Business Owner. May-June 1995.
Cohen, William A. The Entrepreneur and Small-Business Problem Solver. 2d ed. Wiley, 1990.
"The Delicate Art of Price Hikes." Business Week. November 6, 2000.
The Facts About Pricing Your Products and Services. Small Business Administration, 1996.
Marn, M.V., and R.L. Rosiello. "Managing Price, Gaining Profit." Harvard Business Review. September-October 1992.
Meyer, Peter. "Is the Price Right?" Across the Board. July 2000.
Pindyck, Robert S., and Daniel L. Rubinfeld. Microeconomics. 2d ed. Macmillan, 1992.
Plack, Harry J. "Price Hikes Not Always a Bad Thing." Baltimore Business Journal. July 14, 2000.
"The Power of Smart Pricing." Business Week. April 10, 2000.
Pricing Your Products. Small Business Administration, n.a.
Scott, Howard. "The Tricky Art of Raising Prices." Nation's Business. February 1999.
Walker, Bruce J. A Pricing Checklist for Small Retailers. Small Business Administration, n.a.
Winninger, Thomas J. Price Wars: How to Win the Battle for Your Customer. St. Thomas Press, 1994.
SEE ALSO: Loss Leader Pricing; Penetration Pricing