How to Define Pricing in Marketing For Small To Medium Sized Businesses? 💰
Pricing and marketing – whether online or offline – is the greatest source of profitable revenue growth for the majority of small businesses and a sustainable source of value capture for large businesses. But still, many business owners ask: how do we define pricing in marketing?
Pricing strategy for your small business will set the standard for your product or service in the marketplace and is an important aspect to both your bottom line and your competitive edge. Early in the life of your small business, for example, you really want to attract and maintain your intended market as deeply as possible, and pay close attention to what they value most and any past fluctuations in competition and demand.
For those that are unfamiliar with pricing: The pricing you charge customers is a vital component in the marketing mix accounts and the number one driver of profitable revenue growth that the business creates. In simple terms, price is the amount of money you as a small business owner charge your customers for using your products or services. And, hopefully, to some degree, you have set your customer prices with a view to what your customers value the most about your products or services.
In summary, then the price is more than a number. A price is the summation of the total of all the financial, physical and psychological benefits of your offer to customers like money, energy, time, and mental costs.
Price is not just the cost of the product (i.e., what you pay for the product) with a mark up on top to target an agreeable margin. This is a very old fashioned view of pricing and one that leads many small business owners to financial ruin. We want you to avoid this common trap.
Price is a very important profit driver for small businesses or early-stage startups. In fact, a 1% improvement in pricing increases profits by 6%. So you need to set your prices correctly and avoid guessing. The loss or gains are too big to guess.
So, in this article, we will tackle the topic of how to define pricing in marketing for small businesses. We will also discuss the different perspectives on price so that you know the strengths and weaknesses of differing approaches and methodology.
We argue that even smaller businesses should make sure that the price of a good or service is a price that the customer is willing to pay and a price that provides revenue for the company.
At Taylor Wells, we believe that setting a price for products or services is one of the most significant decisions that a small business can make.
By the end of this article, you’ll understand exactly how to define pricing in marketing and how to set and manage price to ensure profitable revenue growth for your business in the best way possible.
Define Pricing in Marketing
Let’s define pricing in marketing. Pricing is the method of identifying the value a small business can get in the exchange for the goods and services they sell. As a small business owner, you hopefully sell goods or service for a price that your target market is willing to pay. Not only that but at a price that generates good margins for your business.
However, this is not always the story. And, in many instances, pricing is the number one reason why many small businesses fail. Price too high and you price yourself out of the market. Price too low and you forever struggle to sell above costs and eat into your hard-earned revenue and profits.
Knowing this then, below are key factors to consider the next time you set a price for a new product or service:
- Nature of the goods or service
- Price of similar goods or service in the market
- Target market
- Cost of production (such as raw material cost, labour cost, machinery cost, inventory cost, shipping, etc.
- External factors (such as the economy, legal issues, government policies, etc.)
What are the Pricing Objectives for the Small Business Owners?
The objective of pricing should be to give you direction on where to take the business as it grows. However, often the objective of pricing devolves into keeping your head above water or fighting with competitors on price to avoid market share grabs.
To survive in the market
A major pricing objective of a small business is to set prices as best you can. Price at the early stage of business is a great mechanism to help you gain traction in a new market without alerting opportunistic competitors to what you are doing.
Many companies now face the threat of price wars with larger competitors or have to deal with shifting customer’s buying behaviour, tastes, preferences, etc. A healthy price objective for small businesses, then, should be to set a price that doesn’t mean that are selling below costs. In the early days, this may mean a price point that covers both the fixed and variable costs you incur during this initial phase. But don’t stop there. On top of cost considerations, try to incorporate the following in your price-setting logic:
- Develop your brand name to build recognition of your small business and to build resilience if a price war ensues.
- Find unique values which your business can add to stand out in the marketplace.
- Provide products or services that are exclusive to your business to ensure further protection from falling prices.
- Eliminate high maintenance goods and determine what customers do and don’t want through market research.
Maximise the current margins
Many smaller businesses forget to consider the supply and demand dynamic in the market and in turn forgo lots of hard-earned margins. Remember, even for a small business, you want to try and set your price in line with the demand for the product and the substitutes that are available to satisfy that demand. The higher the demand, the higher will be the price be and the more money you will make. The best examples are the seasonal supply and demand of goods and services.
Once you understand consumer demand within your market, review your own costs, supply chain, and profit goals as a way to inform your choice of pricing strategy. Below are a few pricing models to consider:
- Cost-plus pricing: The selling price is determined by adding a markup to the unit cost.
- Competitive pricing: Setting a price based on the price of the competition.
- Value-based pricing: The price is based on the perceived or estimated value of a product or service.
- Price skimming: Setting the price high initially and then lowering it as competitors enter the market.
- Penetration pricing: The price is set low to rapidly enter a competitive market and provoke word-of-mouth recommendations, only to be raised later.
Gaining enough market share quick enough to stay alive and avoiding a price war
A price war is when competitors continually lower their prices to undercut one another and gain market share. This almost never works out in a small business’ favour, especially when competing against globalised pricing. Many smaller businesses offer low prices for their products because they assume this will capture a bigger market share quickly. However, what it actually does is alert competitors that you want to compete on price and the bigger operators use their scale to crush you.
It is highly likely that the market you operate in is becoming more mature. This may mean that there is some element of oligopolistic competition in your market which in turn is encouraging more finesse in devising marketing strategies.
So, when you start out try to manage the urge to lower prices and consider the changing competitive landscape. Yes, lowering prices may help you increase volumes now, but it is a short term move and there is no guarantee that it’ll work. What’s more, you can no way compete with bigger firms that can easily leverage their economies of scale to win price wars and beat you into submission. Also, supplier consolidation is a big trend in Australia and many businesses are using this approach to gain market dominance quickly. A small business can’t do this. Take note, to consider all scenarios when setting low prices as often the consequences are not worth the loss.
Quality perceived by the customers on the product/service
It is very common for small business owners to set product price or adjust prices based on their costs or by exclusively looking at the competitor’s pricing. This is a flawed approach and neglects the total economic whole value of your offer to customers.
Consider instead then what the maximum price of your product is (your price ceiling) and work back from there (i.e., the total value to customer minus barrier to purchase). Ask yourself: Are you serving price-conscious consumers or an affluent niche? What are the value-added services, if any? How do you compare to your competitors?
Maybe trial a minor price change for low-risk products. How do your customers respond to the change in price or a new price in the market? How does demand change when nothing changes but the price? What is the highest price the market will bear?
Often, you will find that your customers tolerate a price change much better than you thought they would. However, be prepared to justify the price change, especially an increase. Because no one is happy about paying a higher price when they don’t understand the reason for the increase or if they find there was no reason behind the increase except you wanting to increase your profitability. This doesn’t go down well with customers.
Different Viewpoints on Price
The notion of price differs depending on the frame of mind from which it is being viewed. Let’s define pricing in marketing from different perspectives.
How do you define pricing in marketing from the customer’s perspective?
The customer uses various criteria to identify how much they are willing to spend, or how much they are willing to pay, to satisfy their needs. Normally, the customer wants to pay as little as possible.
For the company, it can either increase the perceived benefits or decrease the perceived costs to increase value. These two components should be considered as elements of price.
However, to some degree, perceived benefits are the opposite of the perceived costs. For instance, paying a higher price for an item is remunerated by having that expensive product displayed in one’s home. Other perceived benefits related to the price-value equations are convenience, status, brand, the deal, choice and quality.
On the other hand, perceived costs consist of the actual price tag printed on the product and other additional factors. As mentioned, perceived costs are the exact opposite of the benefits.
In the end, it is favourable to look at the price from the customer’s viewpoint because it helps define value which the most vital grounds for building a competitive advantage.
How do you define pricing in marketing from society’s perspective?
Taken from the barter method (or exchanging of goods of the same value), the monetary structure of each society gives a more convenient way to buy goods and gather wealth.
The two distinct ways that price plays in society are a rational man and an irrational man. The first one suggests that the outcome of price manipulation is predictable (the basic belief underlying economic theory). The second one acknowledges that man’s reaction to price is unpredictable at times. And pretesting price manipulation is a vital task.
Why is Price Essential to Marketers?
Pricing directly affects the revenue of the business, thus, setting the right price is important to a small businesses’ success.
Price is essential to small business owners and marketers alike. However, the biggest difference between getting value-based pricing right and wrong it’s how a small business assesses the value that customers see in their products and the customers’ willingness to purchase the product or service.
Setting the price of a product/service is one of the most vital management decisions and for many reasons (as listed below).
- Price is the only component that affects profits rather than costs (which affect product, place and promotion of the marketing mix). Price is the element that makes or breaks a business.
- Modifying the price has a great impact on the marketing strategy. Depending on the price elasticity of a certain good, it often affects the demand and sales also.
- Price plays a significant role as a competitive weapon to assist a business in utilising market opportunities.
- Pricing also determines how customers perceive the product. A higher price means higher quality and associated with luxury. On the other hand, a low price means low-quality products too. Setting a price that either too high or too low will limit the growth of the business. The worst part is, it could cause major problems for sales and cash flow.
Yes, admittedly it’s tough to get the pricing right when you don’t have a process to determine customer value. This is because there are a lot of unknown and known factors to take into consideration. Also, many uncertainties on whether a price change will have the desired effect.
The law of demand says that, for almost all products, the demand is lower if the product is priced higher. Meaning, sales will drop if prices are increased. However, a high price can also mean high margins.
Price can lead to a company’s survival or downfall. Therefore, a business must set the right price and do the heavy lifting to work out what their customer really value about their products.
Impact of Pricing in Marketing
What is the impact of price on small business marketing? Let’s take a closer look at their relationships. The two ways wherein pricing affects business and marketing performance are budget and efficiency.
1. Marketing budget
The price of a product is a determining factor of how much profit the product will generate. Having a high profit means having more money to market a product. On the other hand, low profit means less money in marketing the product.
2. Marketing efficiency
The probability that customers will buy your product is higher when you are priced a bit lower than your rivals. Thus, it gives the business a sign of effective marketing.
However, there’s a clear challenge if having high prices create a larger marketing budget. And low prices increase the efficiency of the marketing campaigns. The dilemma of the business is finding the right price that is ideal for both the marketing budget and efficiency.
It even gets more complex when you think that this balance is not the same for every product on the market. The reason is, customers don’t value items the same way and react to price changes accordingly.
- It is really important for small businesses to invest more time and effort in their product pricing. That is, to avoid a drop in sales or market share.
- How does price relate to marketing for a small business then? Price is significant to small business marketing because it provides business owners with a tangible number of how much customers are willing to pay now and a view to the future too, i.e., how much more or less they would pay in the future based on changing market conditions and economics.
- Increasing or decreasing the price has a deep impact on a small business’ marketing strategy. In terms of demand and sales, as well as price elasticity of the product/service.
Setting a price for its products/services is one of the most significant decisions that a business will make.
Having low-priced products is not usually a strong position for small businesses. Pricing too high or too low gives customers an idea of what to expect from a business.
It’s not easy to get the pricing right. There are a lot of factors to take into account and many uncertainties on whether a price change will have the desired effect.
It is highly recommended that you consider value-based pricing to improve your pricing setting process and accelerate your business growth.
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