I like to think that pricing is more than a random estimate or “copying” of what others are doing. Pricing is a key function in the value equation, Value = fn(price / sum (service + quality + access)). To create value, companies build products and services and wrap them around the product. Consumers create value by subconsciously assessing the price being asked for the perceived quality, and perceived service, and perceived access. If the customer perceives a high ratio of quality, service, and access then the price may go up and they are satisfied with the higher value. If the customer perceives a low ratio of quality or service or access, then the perception of price may go down.
Consumers have been trained to identify value in categories and their value metrics vary as well. For example, a homeowner might value lawn services differently than the quality of produce at a supermarket. The quality of the product has to be in an acceptable range that exists in the consumer’s experience or the price will have to be lower or completely unjustified. That same value perception when applied to law services might rank service and access higher than the quality of the actual job. Understanding your customers and their buying behaviors is an essential key to building a better pricing structure. Merchants often build pricing for products in the absence of any customer insight other than the number of units sold. Understanding WHICH customers buy WHICH products and at WHAT price and margin is the key to better pricing of products and services.
Products are put to market at Cost + some markup. The Markup may be a simple as keystoning (doubling the cost of the item) or may include some insight into the higher value of an item and have a significantly higher markup. In apparel, markups are generally 3-5x of cost and in some instances even higher than that depending on whether or not the retailer is also the designer and producer of the apparel. Retailers that sell third party apparel generally keystone product costs or accept MAP (minimum advertised pricing) required by manufacturers trying to promote value for their brands (e.g. Nike, UnderArmour, NorthFace, etc.).
EDLP is a strategy that is used to keep pricing at a low point, possibly with inferior goods that are seen as “disposable” meaning the customer does not expect the product to last forever but pays a lower price for a suitable product. Walmart is famous for their everyday low price guarantee and dollar stores generally follow a similar approach and certain specialty retailers as well.
Product Bundles are typically products that are complementary and bundled together to increase customer basket and drive sales but can also be used to move slower selling merchandise by bundling it with faster turn merchandise. Bundle pricing is normally a discount approach to pricing after a product is introduced using High Low or EDLP.
Market Penetration Pricing is an aggressive strategy to capture market share and engage customers with a new product, service or brand. Aggressive pricing at temporarily lower margins is common when a company trying to enter a market is newer and less well known compared to other brands or the product is clearly a superior product to others already in the space.
The inverse of Market Penetration Pricing, Price Skimming is to try and command premiums when being first to market with a product and hold those premiums as long as the brand can acquire or beat sales targets. The “first mover” premium enables a company with a High Low strategy to gain share and assert product dominance but is not a viable solution for EDLP organizations because consumers have less confidence in premium prices when trained for every day value.
Psychological studies on humans has shown that consumers think that $14.99 is $14 and that $199 is less than $200 dollars. These are truths but many companies round up to the $.99 because they can gain incremental dollars over a keystone strategy that places a product at say $47.25 – $49.99 is considered equivalent. Understanding that psychological phenomenon enables marketers to earn higher margins than normal.
Segmenting customers based on spending behaviors can allow you to see the differences in pricing and propensity and sometimes a surprise along the way. Quintile 1 has an Average Unit Retail (AUR) price that is 4% above the average. But Quintile 5 has an Average Unit Retail price of 21% above the average. Why the difference? The Quintile 5 customer is a deal shopper and consumes more discounts to have a Higher RETAIL price but has a lower overall net spend with fewer trips with more discounts. Offering promotions to Quintile 1 may not be necessary but offering them to Quintile 5 is required in a High Low pricing strategy to get them to buy higher-priced items. Better margin management includes better marketing communications to ensure your pricing strategy works properly.
As you are pricing products for consumers, there is a lot to consider. In the High Low scenario marketers often budget into their markup the markdowns they think will be required to move products and the margin expected to be retained with a target goal of Maintained Mark Up (MMU) on completion of sale. The High Low strategy makes consumers feel like they are “getting a deal” which they technically are when products are on sale but the targeted MMU was set at the “deal price” before the product hit the shelves. Additional gross margin above the MMU could indicate the discount budget was overstated and result in less generous offers or even higher prices for the item in the future.
No matter what your approach, pricing does in fact matter quite a bit when selling products and services. Price is a function of value, quality, service and access and if you can measure those components you can do a much better job of pricing your products for higher margin performance. But the real key is to use customer insights to assess the willingness of different customer segments to pay different prices for similar or even the same items depending on the equation of price, quality, service and access. Analyzing strategic customer segments in categories and subcategories and even among core products will enable you to identify price points and promotion strategies to optimize margin performance and build a more profitable business.