Pricing decisions are strategic and critical to the success of your company. The prices you charge for your products affect demand, thus causing a ripple effect across your company’s output, revenues, costs, and income.

• With a sound pricing strategy, your company is in a better position to perform these important tasks:
• Launch and manage a product through its life cycle
• React more nimbly to competitive price moves
• Adapt to seasonal fluctuations
• Analyze special-order bids
• Maximize profitability

This article provides tips for establishing a product pricing strategy that will help prepare your company for success.

Gather pricing-related intelligence

Before you can develop a pricing strategy for your product, make sure that you have a thorough understanding of the important issues of customer demand, competitive environment, product strategy, and product costs.

Customer demand

• What is the price elasticity of demand (a measure of how price changes affect consumers’ willingness to buy a product) for your product in different customer segments?
• How does seasonality affect customer demand and elasticity for your product? For example, how does the back-to-school season affect personal computer demand and elasticity?
• Is your company able to satisfy varying levels of customer demand for your product?

Competitive environment

• Does your product offer clear and considerable benefits over competitive products? Or is your product a relative commodity in the marketplace?
• Can you estimate the cost structure for your competitors?
• What prices have already been established in the market for this type of product?

Product strategy

• What strategic role do individual products play in your company’s overall portfolio? For example, is the product a traffic driver?
• Where does your product stand in its life cycle? That is, is it a growth product, a mature product, or a product that is in decline?
• Can prices of one product be set low in order to drive the sales of a complementary product that may have higher unit volume and profitability? For example, will setting low prices for razors (relative to competitors) enhance sales of razor blades?

Product costs

• What is the full cost per unit of your product (including both fixed and variable costs)?
• Have you accounted for the expected and unexpected life-cycle costs, including the initial research and development costs, potential recalls, litigation, warranty, and maintenance?
• What are the risks to your cost structure? For example, an auto manufacturer should understand the impact of a sudden increase in steel prices.

Review pricing alternatives

After you have gathered key pricing data, you should review pricing alternatives. Depending on your business and industry, it may be necessary to select more than one pricing alternative. Also, keep in mind that the pricing alternatives you choose may have benefits or drawbacks, depending on your industry and business situation.

Implement the pricing strategy

After you’ve selected the appropriate pricing strategy for your industry and business situation, you can implement your strategy by using these helpful tips:

Identify product roles Work with marketing to identify specific strategic roles for products (and product lines) in your company’s portfolio. For example, you may price for low-unit margin and high-unit volume on an entry-level product, such as a Honda Civic. But you may price for high-unit margin and low-unit volume on a product with luxury appeal, such as an Acura NSX.

Product roles may already be understood by key players in your company. But by bringing the discussion to the forefront, everyone will be more aware of how product pricing can support your company strategy.

Tighten your relationship with sales Set up clear communication channels with your sales team. Salespeople out in the field can provide firsthand information about how customer demand for your product changes in relation to shifting prices and competitive actions.

Track customer profitability Use spreadsheet software or a tracking tool to identify profit margins for a product that is based on customer, market, or geography data. The tracking tool will reveal which products have exceptionally high margins. Tracking will also help forecast whether a drop in prices will increase overall profitability.

The challenge with this task is to set up a process to effectively allocate indirect costs down to the product level. Without an effective way of allocating these costs, you could undercost or overcost products, which would more than likely affect your pricing and your estimates or product profitability. Activity-based costing (ABC) systems can help track the appropriate level of detail for product costing and pricing decisions.

Take a global view Understand how exchange rates and economic conditions in other countries could affect pricing. Keep in mind the recently weaker dollar, which has made American exports cheaper abroad and foreign imports more expensive to Americans. Another global consideration is the purchasing power of different customers across different countries, which may dictate the need for different pricing strategies.

Consider the customer perspective Customers may not necessarily view specific product features as the only value they will receive. Be sure to take into consideration all of the related costs a customer may incur such as installation, maintenance, and potential recalls when establishing prices.

Avoid illegal pricing strategies Be aware of pricing strategies that may unfairly limit competition. Some illegal pricing strategies include:

• Predatory pricing Companies that initially set prices below average variable costs to eliminate competition, and then increase prices.
• Dumping Foreign companies that sell products in the United States at a price below the market price or at production cost in the country where the products are produced.
• Collusive pricing Companies within a particular industry that work together to set prices above the competitive price in order to hinder trade.
• Tying Companies that offer unconditional bundling of a second product with a more dominant and necessary product, without the customer ability to decouple the products. This gives an unfair marketing advantage to the company with the dominant product, while placing other companies that sell the second product at a distinct disadvantage.

By developing a formal pricing strategy, you can prepare your company for success. If you understand your customers, competitors, product roles, and the full costs of your products, you can knowledgeably select and implement a pricing strategy across your product portfolio. The rationale and structure for the pricing strategy you choose should be clearly communicated across your company.