The Price Is RIGHT: 5 Pricing Models Explained
Determining the most appropriate pricing model for your business is tricky and takes considerable research, planning and testing before full implementation across all of your products and services. Of particular concern to many business owners is the impact of price model changes on the customer and their standing among the competition.
When determining how to best price your products and services, consider:
- The current positioning of your products and services. Are they positioned as low-cost options, luxury offerings, or somewhere in the middle? The pricing of your products and services must be aligned with how they are positioned in the marketplace. The higher the quality of your products and services, the higher the price you can command from customers.
- Your customers. Will your customers tolerate change to the pricing model for your products and services? If so, how much change will be tolerated? How much “lead time” is necessary before implementation? How will pricing affect the demand for your product?
- Your costs. What are your costs to produce your products and services? Don’t consider just the current costs, but also expectations around increases in costs in the near future based on the industry, suppliers, competition and demand. You don’t want to have such an exact pricing model based on current costs that pricing must be changed within a few months.
Don’t skip researching what is commonplace for your industry, for the region, or among your competition. This doesn’t mean you must mimic what everyone else is doing. But you should be aware of what is being done, and what is not. Inevitably, others have done their research, and there may be a good reason why a particular pricing model is not used for products and services similar to what you offer.
What do you want to accomplish by how you price your products or services? Is profit maximization essential? And are you focused on short-term or long-term goals? You must choose one or the other as a goal; it is not possible to maximize both short- and long-term profitability with the same pricing model.
Are you trying to differentiate yourself from the competition? If many of your competitors offer lower-priced products or services, you may want to differentiate yourself by focusing on the high value (and therefore higher price) of your products and services. You’ll need to be really clear about how you are different than the competition to be successful.
There are a variety of pricing models you can choose from. For example:
- Cost-Plus Pricing. This model is frequently used to maximize profits within the business. It entails adding up all of your costs associated with offering a product or delivering a service and adding on a percentage for profit.
- Value-Based Pricing. This model entails setting your price for your products and services based on the perceived value to the customer. The price to one customer may be different than the price offered to another customer.
- Hourly Pricing (time and expense). For businesses that offer services, you may choose to offer hourly pricing (time and expense) for your services. In such a situation, you invoice the client for all expenses (such as mileage to client site, etc.) and for each hour of work at a set hourly price depending on the services being offered.
- Fixed Pricing. This model charges the client a set price for a service offered. For example, a project-based company may charge a client a price of $25,000 to complete a project regardless of how many hours are expended or how many resources are involved. Of course, in determining your fixed price model you’ll want to consider the complexity of services and, on average, how much time and resources must be committed to the project. Without a true understanding of the costs, a business can lose money on fixed-price contracts.
- Performance-Based Pricing. In performance-based pricing, you invoice your customer based on the performance of the product or service you deliver. Such a pricing model might only be used for certain clients and in specific situations as it requires significant agreement (in writing) between you and your client. You must spend the time up front setting guidelines for performance-based pricing models and developing very clear and unambiguous metrics for achievement of the objectives. If you are in a rush, or getting pressure from the client to move forward, do not attempt performance-based pricing models.
When choosing your pricing model, test it out first. If you are about to roll out a new product or service, you may choose to test out the new pricing model with that new product or service. Certainly keep customers in the loop about changes you are making. Choose a group of core customers to test your pricing model. A simple conversation with, or e-mail to, your customers explaining what the business is doing and why will help to socialize the pricing model change and get buy-in and support. Certainly, you will hear if the change is not acceptable. Better to know that before you make the change! Unless you are a brand-new business just opening your doors, you will need to socialize changes to your pricing model prior to implementation.
Much like everything else you do in your business, plan upfront and get input from those you trust and whose opinions you value. Understand what your customers want and be prepared to clearly delineate the benefits (to them) of the new pricing model you select for your business.
This topic and more are included in Vistage Connect™ peer advisory sessions.
Gina Abudi is president of Abudi Consulting Group, LLC, providing strategy and implementation around projects, process, people and technology to businesses of all sizes. Gina can be reached via her website, AbudiConsulting.com.