Saturday, August 12, 2006

The Art of Pricing

Mohamad Rafi in this book provides an easy to read book about pricing strategies. There aren't complicated economic demand and supply curves here, just basic principles on what factors affect pricing and tactics on how to maximize your profit.

In the book, he often refers "hidden profit", ways in which you can get more bang for your product/service.

He gives an example from Lloynd Hansen's of Ford who calculated that an additional of 1% of net profit margin increased Ford's net income by 33% and cash flow by 45%.

Rules of Price Cuts:
  • Some customers but not everyone can get a price that is below average price.

  • But to stay in business, your average price needs to be greater than your average cost.

  • Prices should not drop below the production.

  • Price cuts should be targeted and discrete.

  • Make sure that discounted sales do not block purchases from those willing to pay full price.

It's all about value. Everything is about how much a customer values your product or service.

There is no such thing as loyalty. No one buys an inferior product at a higher price.

The 5 Factors of Value:
  • Price and availability of substitutes. Compare your pricing and that of competitors and substitutes.

  • Characteristics relative to competitors. Consider brand name, convenience, quality, features, attributes, service, style.

  • Income. As income increases for a customer so are they willing to spend more. If you just get an inheritance so will you value more things or are willing to spend more.

  • Price/Strength of demand for related products. Related products also affect demand. For example, high oil prices affecting sales of SUV's. Or COE's in Singapore affecting demand.

  • Market environment. A fad can affect sales demand. For example, the airing of a documentary on 60 minutes extolling the benefits of red wine. Or the enhanced status of Hush Puppy shoes creating a demand.

The amazing observation about the 5 factors is this: 3.5 out of the 5 are beyond your control! Only your features and your own prices are within your ability to manipulate.

Different people value things differently. You will be amazed that asked the price of an item 2 persons can come up with wildly divergent valuations.

Differential Pricing Techniques:
  1. Customer Characteristics. Age, gender, organization affiliations, proximity affect value in the minds of customers.

  2. Hurdles. Coupons, sales, memberships, size, and conscious actions are hurdles that help you identify and sell products at different valuations. For example, some people with lower valutions of shoes will wait for warehouse sales or the like to buy goods.

  3. Time. Some people are willing to pay more to get certain items first, others are happy to wait till the price drops.

  4. Quantity. Lower prices but at increased volumes.

  5. Distribution. Different prices depending on where they buy it. A drink from a mini bar costs far more than one from the Walmart.

  6. Mixed Bundling. Sell it individually or in promo packages enables you to charge different prices. A good example is Amazon's 1 + 1 bundling whenever you check out their online catalogue.

  7. Negotiation. Each individual negotiates and you assess the eagerness and the value he places on your product.


Examples: You don't just have coke, you have diet-coke, vanilla-coke, lime-coke, cheery-coke, etc. You have leaded, unleaded, 95 octane, 98 octane.

7 Techniques provided:

  1. A La Carte.

  2. More is Better.

  3. Less Can Be Profitable.

  4. Add or Subtract Features.

  5. Expedited Service.

  6. Avoid the Wait.

  7. Uncertainty.

Segment Based:
  1. Interval Ownership. E.g. Time-share for houses, private jet aircraft. Benefits are less maintenance and convenience.

  2. Bundling. Bundle slow-moving items with popular items. Or bundle the product and maintenance services together. Or consider Extra-Value Meals. Or Happy Meals that sell toys only with the meal.

  3. Leasing. Allows customers who have cash-crunch to use your product. Also allows trade-ups to better products later.

  4. Prepaid. Can make it easier for some people to purchase and open up new markets. E.g. kids with prepaid phones. Also allows expiry of unused balance. Cash upfront.

  5. Rental. Allows short-term usage. (Leasing is long-term).

  6. Two-Part Pricing. Pay upfront a high membership fee, but a low usage fee. Or pay a certain amount and additional above free allotment. E.g. post-pay mobile phone packages.

  7. Hurdles. Differentiate customers who are different needs.

  8. Payment Plans. No interest charged. Interesting note: Make them pay in person, build rapport in each visit to prevent delinquency.

  9. Customized. Use formulas to determine price. Higher for risky customers, lower prices for low-risk ones and to steal them away from competitors.

  10. All-You-Can-Eat. It may kill you or it may attract people who don't want to be burdened watching the cost meter.

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