Price is the most overlooked of the four P’s of marketing
Pricing is the most overlooked yet easiest to adjust lever of a company’s business. Yet, not enough business invest enough time and effort to explore an optimal pricing strategy, either leading to dissatisfied customers or leaving money on the table. For a US$100 million revenue company, a minor price adjustment of just 10% towards the right direction can easily result in additional revenue of $3 - $7 million. If the adjustments required is bigger than 10%, more can be reaped. This means that the relative impact on profits is even higher, 20 to even 60% in cases we have seen. No other lever has a higher impact on improving profits!
“The moment you make a mistake in pricing, you're eating into your reputation or your profits.” - Katherine Paine
Traditional approaches to price setting
Many companies continue to use primitive approaches to setting price. Among the two most common ones are the cost-plus approach and the competitor-sizing approach. Cost-plus pricing is the selling price set by evaluating all variable costs a company incurs and adding a markup. In the competitor-sizing approach, the company compares the “quality” of their product relative to competitors and charges a price according to this relative comparison. This approach is also called strategic pricing approach although one wonders how strategic they truly are. A key assumption of the strategic pricing methodology is that your competitors know what they are doing, otherwise it really is a case of the blind leading the blind. Both are useful as a form of bench-marking, however relying solely on such approaches often leads to either overcharging or leaving money on the table.
“Pricing is branding.” -Richie Norton
Price Elasticity of Demand
To understand pricing, it is useful to have a good grasp on an economics 101 concept - Price elasticity of demand. Price elasticity is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price.
“Find the right price for an irresistible offer, which, by the way, isn’t necessarily the lower price.” - W.Chan Kim
If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive to price changes). On the other hand, a product is deemed inelastic if a large change in price is accompanied by a small amount of change in quantity demanded. A product’s demand is unitary elastic when an increase in price will lead to a similar percentage drop in quantity demanded. The same product can exhibit different elasticity at different price points. Elasticity of demand is lower at low prices and vice versa for the exact same product. How then do we use this information?
What price is optimal?
For instance, assuming the price elasticity of a product is 0.5 at point E1. This implies a 20% increase in price (say, from $30 to $36) will lead to a 10% decline in sales (say from 100,000 to 90,000) - point E'. As one can see, revenue would increase from $3,000,000 at E1 to $3,240,000 at E', an 8% increase. The loss in revenue of $300,000 from the contraction in units sold (-10K) is more than offset by the $540,000 expansion in revenue arising from the rise in margins (+$6). For any inelastic-demand product, the yellow box (resultant rise in revenue due to higher margins) will always be larger than the blue box (resultant drop in revenue from lower units sold). The converse is true for an elastic demand product. Optimal pricing for the product occurs when prices are set such that the demand elasticity is equals to one.
“Do not compromise on the quality and your customers will not negotiate on the price.” - Amit Kalantri
How then can one determine where such optimal price range lies? Are there “qualities” of a product people places higher priority that they are willing to pay more for these embedded features? How do we find out what these features are and how much more are people willing to pay for those? There are many ways to go about the above and I will attempt to answer these questions in my next post.
I am currently working with a Singaporean company with big data capability to extract such pricing and volume with extremely high fidelity, for products that derives a significant portion of their sales online. In addition, we can help bring your products to new overseas market such as US, Europe and Southeast Asia and using the technology, provide advice on pricing adjustments, procurement, product development and marketing among others.
For those interested to find out more, please email firstname.lastname@example.org for more information.
Kok How Lee is an Entrepreneur, Consultant, Strategist and Economist. He founded KeyHole Insights - an economic & strategy consulting firm focusing on Asia, in particular China and Southeast Asia, delivering customised advice to help organisations make better decisions, implement those decisions and deliver success.
Kok How graduated with an Executive MBA from both INSEAD and Tsinghua University. He also holds a MSc (Financial Engineering) and BSc (Economics) degree from the National University of Singapore.