Pricing

Many businesses - especially new businesses - struggle in finding the right pricing mix for their products or services. Your business does not want to set its prices too low giving up profits and signaling possible poor quality but it also doesn't want to set prices too high for fear of driving away customers - especially while the economy remains weak as consumer and business spending is down or at the least more selective.

There are many, many schools of thought regarding how businesses should set their pricing and just as many ways of analyzing your business's pricing models.

One school of thought is to base pricing on your competition. If your competition is offering a similar product or service or one that accomplished the same results, your business does not want to set its prices far above the competitor's prices for fear that potential or current customers will easily switch to the lower priced item. Or, set them lower than the competition out of fear a pricing war may ensue - a war that neither side would ever emerge as a true winner.

Another is to base your business's prices on its business model. Example, your business needs 12% in profits to ensure that its costs (fixed and variable) are being met as well as earning a realistic return for the you - the business owner - if those funds and efforts could be used elsewhere to earn better returns, then they are being wasted in this business venture. Thus, prices should be set to ensure the business is earning the desire return - one higher than it could get elsewhere.

Yet, another is to take a market value approach and set prices at levels the market your business is in will bare. A clear example of this might be based on your location. A 1,200 sq ft retail space might sell for $100,000 in Texas while that same space could easily return twice that amount in San Francisco. The market in San Francisco is able to bare the higher rate simply based on its market or location.

Regardless of your school of thought, I want to add another wrinkle to the pricing dilemma. Clayton M. Christensen and others like him have poured countless hours of research and analysis into the buying decisions of customers - regardless of where your prices fall, the bottom line is to entice customers to part with their hard earned money - thus understanding their buying behaviors.

Based on a buying hierarchy model first outlined by Windermere Associates, most customers follow a four phase buying pattern - with the last phase being based on price.

These phases are as follows:

- Functionality - Where a product or service meets a certain need or does a certain thing that cannot be accomplished in any other manner.

- Reliability - When two or more competitors offer similar products that have the same functionality, consumers turn the competitor whose product offers the better reliability.

- Convenience - When competitors now have products or service that offer the same functionality and the same relative reliability, consumers turn to convenience - those products that are the most convenience to use and the companies that are the most convenience to work with.

- Price - Lastly, price. When competitors all have similar products or services that offer all the attributes above in very similar manners - then, the product or service essentially becomes a commodity and at that point must compete on price (following the schools of thought outlined at the beginning of this article).

Thus, the first question that any entrepreneur should consider when setting prices for their offerings is; 'Is this product or service a commodity?'

If it is not, then it should be able to compete on one of the four phases listed above - without much regard to price.

A great example of this is Apple's iPhone. When this smart phone device first entered the cell phone / PDA market - it was extremely unique in its functionality - helping cell phone and PDA user do things in a ways that they were unable to do before. As consumers flocked to this new device based on this functionality - they were willing to pay upwards of $1,500 per phone - an astounding amount for a cell phone.

Soon after, other phone manufacturers began duplicating the iPhone's functionality with their own devices. Thus, consumers shifted to the smart phone that offered the greatest reliability. While Apple was smart to partner with AT&T Wireless, Verizon began marketing their wireless services and their partner's devices as the most reliable network / device combination. Regardless if Verizon's network was better, they were able to sell it to the cell phone using public; driving demand to its network and its partner's devices (devices with the same functionality as the iPhone).

Again, in time, when the market or consumers perceived that all networks and their partner device manufactures contained the same functionality and reliability then their focus shifted to convenience - convenience like a consumer already being under contract with a certain network (offering a certain partner's phone). Thus, this consumer would not have to break a contract (and pay the fee) in order to purchase and use a similar smart phone device.

However, now we are beginning to enter the second generation of these smart phones. Many of these first generation devices are very similar in functionality and reliability and are offered on nearly every network - thus, they are becoming commodity like in nature. Therefore, Apple is now on the verge of introducing its next generation phone (hopefully with functionality that no other smart device has) - but, in the mean time, prices of current smart devices have fallen dramatically - today, a cell phone consumer can easily purchase a first generation iPhone for well under $100 - as it now has to compete solely on price.

Bottom line - know where your products or services fit within this buying hierarchy. Doing so many save you, the entrepreneur, countless hours of worry about prices - especially if you and your business do not yet have to compete on price alone. The idea here is not to purely focus just on pricing but too how your business can market its offering using the four phases of the buying hierarchy and actual customer buying behavior.

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