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Pricing your Products

Updated on January 4, 2014

The Price Line

Price setting is one of those activities that has a profound effect on the profitability of a business. The biggest problem is that there is no single right price for any product and that is one of the hardest truths for any business manager to accept. Here is an introduction to the five areas of any market price. Understanding these will make your own price setting easier.

We will start by finding the upper and lower limits of the price curve, break-even and maximum price. Then we will give you three markers along that line that will suit whichever strategy you need to meet with your pricing.

Break-even is the price that covers the costs of producing and bringing the product to market. It is usually depicted in a chart with a horizontal line for fixed costs and a rising line for variable costs based on volume of production. It is vital that you get the calculations right or there will be a huge impact on your profitability, especially if you get the variable costs wrong, never guess.

Break-even usually sets the lower price boundary because no company wants to sell product at a loss. There are cases where companies use a product as a loss leader to stimulate the market or prepare the way for a profitable product, or even occasionally as a competitive action to force the competition out of the market all together. For this article we will assume that there will be no incentive to sell below break-even.

Maximum price in reality is whatever customers are willing to pay in enough volume to meet the company’s financial needs. Rather than go through a long cycle of trial and error that will just lead to a loss of trust among your target customer group you should research all the products that are in direct competition to your own. Find the highest price any competitor is charging for a like for like product and use this as your market maximum.

With the boundaries set in areas that you pricing will rarely venture into we can look at the three areas you will actually use.

Penetration pricing is used to rapidly gain market share by means of aggressive pricing. This will be down at the break-even end of the curve while producing an acceptable profit assuming forecasted volumes are met. The main risk is that volumes are not achieved as competitors join in the lower pricing and a price war ensues that benefits only the customer.

Skimming pricing is charging as much as the market will bear for the product while still moving sufficient volumes. It is a strategy for recouping development and other costs as quickly as possible so the company can cover its investment in a shorter period. Skimming pricing is easier to achieve if the product delivers additional value over the competition.

Sustaining pricing is somewhere around the middle of the curve depending on perceived value. It is the long term price that the product will have as it moves into maturity and will find a good balance between profit per unti and total market volumes.

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The Bottom Line

Getting the price right is a relative thing. You will never be sure whether you could be charging more without impacting your volume of sales or whether lowering your price a little might increase volumes and reduce production costs.

If your are able to sell variants of your product you can test to see whether high or low price has a significant impact. Remember that perceived value is often more important than actual price.

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