Building a pricing strategy is a crucial step in the commercial success of any product or service. A well-defined price does more than just cover production costs; it must also reflect the value perceived by the customer, be competitive in the market, and contribute to the company's profitability. Poor pricing can lead to financial losses, a negative brand image, and a shrinking customer base. Conversely, a wisely established price can strengthen the company's position, attract and retain customers, and maximize profits.
This article will guide you through the essential steps to build a solid and effective price, taking into account the cost price, competitors' pricing positioning, the target customer's psychological price, and the company's strategy.
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The cost price corresponds to the sum of the expenses necessary to produce a good or service, divided by the quantity of services or goods produced. It includes direct and indirect costs. Understanding these elements is essential for setting a selling price that generates a profit. The cost price, also called unit cost, thus corresponds to the minimum unit price at which the company can sell its products or services, in order to avoid selling at a loss.
So how do you calculate the cost price? The calculation is very simple. You just need to add up all the direct and indirect costs and divide the result by the quantities produced.
The formula for calculating the cost price is therefore as follows: ((Total direct costs of the product in question / quantity produced of the product in question) + (total indirect costs / total quantity produced)
When calculating the cost price, direct costs correspond to the costs directly related to the production of the product or the performance of the service in question. In the case of goods production, direct costs mainly include raw materials and production costs. Production costs notably include labor, but also any consumables (for example, fuel or packaging). In the case of a service, it is also necessary to consider any travel required for its execution.
In contrast to direct costs, indirect costs relate to expenses not directly associated with the production of goods or the delivery of services. However, a certain number of expenses are necessary for the operation of the business, even though they are not tied to production. This can be the case for telephone and internet subscriptions, specific software, or quite simply the rent for the premises. These expenses should therefore not be underestimated, at the risk of jeopardizing the long-term viability of the company.
Let us take an example to illustrate the calculation of the cost price. Imagine we are in charge of a hot dog restaurant. We have two types of hot dogs on the menu: the New Yorker and the French hot dog. Our sales forecasts indicate that we should sell 600 New Yorker hot dogs and 300 French hot dogs per month.
For the New Yorker, the direct expenses are :
Bread: 60 EUR per month, or 0.1 EUR per unit (60 EUR / 600 hot dogs)
The ingredients: 300 EUR per month, which is 0.5 EUR per unit (300 EUR / 600 hot dogs)
Labor: 10 minutes of production required per hot dog, at an hourly rate (loaded salary) of 14 EUR, or 2.33 EUR per unit (14 EUR * (10/60)).
Other costs (Toppings, sauces, electricity consumption...): 480 EUR per month, or 0.8 EUR per unit (480 EUR / 600 hot dogs)
So this represents a total of 3.73 EUR of direct costs per New York-style hot dog produced.
For the French hot dog, the direct costs are:
Bread: 60 EUR per month, or 0.2 EUR per unit (60 EUR / 300 hot dogs)
Ingredients: 150 EUR per month, or 0.5 EUR per unit (150 EUR / 300 hot dogs)
Labor: 10 minutes of production required per hot dog, at an hourly rate (fully loaded salary) of 14 EUR, or 2.33 EUR per unit (14 EUR *(10/60)).
Other costs (Toppings, sauces, electricity consumption, etc.): 180 EUR per month, or 0.6 EUR per unit (180 EUR / 300 hot dogs)
So this represents a total of 3.63 EUR of direct costs per French hot dog produced.
As for the indirect costs, they are as follows :
Premises rent: 900 EUR per month
Advertising costs: 100 EUR per month
Various subscriptions: 50 EUR per month
Other fixed costs (insurance, equipment rental, other personnel costs, etc.): EUR 2,900 per month
This gives a total of 3,950 EUR in indirect costs per month. This represents 4.38 EUR per hot dog produced (3,950 EUR in indirect costs / 900 hot dogs produced in total).
The costs in this example are therefore as follows:
Cost price of the New York hot dog = 3.73 EUR (direct costs) + 4.38 EUR (indirect costs) = 8.11 EUR
Cost of goods sold of the French hot-dog = 3.63 EUR (direct costs) + 4.38 EUR (indirect costs) = 8.01 EUR
Before you can position an offer, it is essential to know your competitors' offers. To effectively study the competitive environment, the tool most commonly used is the benchmark. The method recommended by Epsimas is as follows:
Create a table in which each row represents a competing offer (note that a competitor may have multiple competing offers). The first column includes a brief description of the product or service, the second the price (excluding options), and the following ones the various features, options, and/or terms of the offers. By filling in this table with all known competing offers, we obtain an overview of our competitive environment.
This table can then be segmented according to several criteria (price, options, delivery times, etc.). The criterion most often used for segmentation is price. Entry-level, mid-range, high-end, and premium offers can then be identified. This step is essential for determining one's positioning in the sector.
The psychological price is the price that consumers are willing to pay for a product or service. This is the price that will seem fair and acceptable to the majority of the target customer base. The psychological price can be determined in several ways:
In a mature market, it is possible to identify the leaders of each segment, as well as the prices charged based on the positioning and characteristics of their offerings. The leaders in each segment tend to strongly influence the perceived value of products or services. The psychological price of an offering in a mature market will thus always tend to revolve around the prices charged by the industry leaders. It is always possible to supplement this initial work by conducting a survey of the target population (i.e., consumers matching our customer profile).
In a still emerging market, determining the psychological price is more complicated. It is possible to use a combination of a qualitative study with the target customer and a survey. However, in order to obtain the most accurate results possible, it will be necessary to provide respondents with sufficient detail regarding the concept and characteristics of the offer. This must be done while ensuring that framing bias (the influence of question phrasing on the answers provided) or any other bias is avoided.
In this case, another method is possible: that of experimentation. This consists of offering different price levels to several samples of the target population and studying the results. For this experimentation to be effective, the chosen samples must be of sufficient and equivalent sizes, and the offer proposed to each group must be similar in every respect with the exception of the variable being studied.
The positioning of an offer refers to its position in its market, particularly in the minds of consumers. The positioning of a brand, product, or company must always be part of a comprehensive and coherent marketing strategy. This notion of positioning involves many factors, including price: this is known as pricing positioning (price positioning). Beyond the cost price, two essential factors must be distinguished in determining it: the prices charged by competitors and the value of the offer perceived by customers.
Building on the benchmark carried out (cf. 2.1 Competitive Analysis), and once the segmentation is finalized, you just need to identify the segment whose offers show the most similarities with the one currently being positioned. Logically, this will be the segment in which said offer will evolve. By cross-referencing the prices charged by the identified segment and the psychological price of the target customer, it will be possible to determine a relevant pricing positioning.
However, caution is required: the pricing positioning must be consistent with the overall marketing strategy of the company and/or the brand. An inconsistency in positioning can have a significant impact on sales. Let's take an example: A clothing and accessories brand, boasting a luxury positioning, that would suddenly offer certain garments for under 20 euros, would create a positioning inconsistency. Consequently, the perceived value of the brand's products by consumers would be diminished. The most likely result of such an inconsistency would be a drop in sales on the luxury-priced products, as customers would now consider the brand's value to be lower.
Pricing strategy, or pricing policy, includes all the choices and actions used by a company to set its price levels. There are many different strategies, often associated with a particular positioning. The pricing strategy must meet quantifiable objectives and be consistent with the brand's positioning. To be effective, it must be planned according to precise deadlines and integrated into the overall corporate strategy.
The penetration strategy (doubtless one of the best known) consists of practicing prices lower than those of competitors. The objective is to win customers and market share (often at the launch of the product or service) quickly, in order to carve out a place in customers' consumption habits. Another objective of this strategy is the increase in sales volumes, with a view to lowering the unit cost of production.
On the other hand, it must be taken into account that this strategy presents risks. Beyond the weakening of profitability, a potential drop in the value perceived by consumers must also be expected.
A textbook example of this strategy is Sony, when the company launched the PlayStation in the United States in the 1990s. The listed selling price, which was very low for a console at that time, was aimed at quickly winning over the largest possible number of Americans. At the time, Sony was competing with SEGA and its Saturn console, which was far ahead in sales in Japan. However, the higher-performing Saturn had higher production costs than the PlayStation due to its technical specifications. By adopting this very «aggressive» pricing policy, Sony knew that SEGA would struggle to match it. Sony thus completely «blocked» the American market for its competitor, a particularly strategic market for both brands. The strategy ultimately paid off. While the PlayStation established a long-term presence in American homes, production of the Saturn was halted just a few years after its release.
The skimming strategy consists of setting a higher price than that of competitors as soon as a product is launched. The objective is to first target a customer segment that is not very sensitive to price. Once the niche of price-insensitive consumers has been fully exploited, the company can lower prices to reach a larger share of price-sensitive consumers. This strategy is particularly used by brands that have successfully created a loyal consumer community.
The best-known example of a skimming strategy is that of Apple. When a new device from the brand is released, the listed price is always very high, and in no way related to the actual value of the product. But for a large portion of consumers, the perceived value of the product is greater than its actual value. Because having access to a product that only a few consumers can buy constitutes additional added value, as does owning the latest version of a product. Once a new version is released, the price of the product may drop in order to appeal to another customer segment, while the new version in turn adopts a skimming strategy.
The alignment strategy, as the name suggests, consists of aligning one's price with that of direct competitors. By applying this pricing policy, the company takes no risk with regard to price. The primary objective of this pricing strategy is to secure sales, and therefore profitability.
However, this implies that the offer in question must be able to differentiate itself by means other than its price. Without a differentiating element, the offer will go unnoticed in its competitive environment. In a market with very low competitive density, the alignment strategy makes it possible to avoid starting a price war with the few competitors. On the other hand, in a market with high competitive density, it is more advisable to use one's price as a differentiating element.
In practice, an «off-the-shelf» pricing strategy does not exist, although trends do exist. It must be custom-built, according to the factors previously mentioned, but also according to the company's resources (human, financial, marketing, etc.) and all of its offerings. To be effective, the company must also work on its product mix. More specifically, the prices of the various offerings must be complementary without being inconsistent, while meeting specific objectives.
Let's take an example: A gym network might have an offer at 19.99 EUR per month, including only weekday access to the machines, and an offer at 29.99 EUR per month for unlimited access. The 19.99 EUR offer aims for customer acquisition and market share gains, with a very low price compared to the competition. Meanwhile, the 29.99 EUR offer is aligned with competitors' prices. Its primary goal is company profitability. Finally, the network can offer paid coaching sessions or merchandise, the objective of which will be to increase the average transaction value.
In this example, the brand's positioning is not called into question by the loss leader offer. The gap between the two offers remains small and is justified by the terms of each offer. On the other hand, if the loss leader offer were 19.99 EUR per month and the unlimited offer 79.99 EUR per month, the brand's positioning would be inconsistent. In this case, the consumer would find no justification for such a gap between the two offers, and both offers would lose credibility.
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