Chartered accountants in business roles are frequently involved in pricing decisions. This makes sense: pricing must ensure that goods and services are sold at a profit, taking into account all of the relevant costs. However, proper pricing requires more than applying a mark up on the product cost, it needs careful and consistent management of a number of issues.
‘Value-based pricing: the driver to increased short-term profits’ by Andreas Hinterhuber and Evandro Pollono in the May 2014 issue of F&M Faculty magazine, argues that pricing can have a much bigger impact on profitability than other tactical measures such as growth or cost reduction. The faculty* are giving complimentary access to the article, view it here.
Bibi Martin of BM Interim Management Ltd offers eight Steps to better pricing
Understand your market and assess your prospective customers’ perceived value of your product or service. Assess how your customers will value the product or service. Look at the price of comparable or alternative products in your market – taking account of actual selling prices as well as list prices. Use market research and your sales team to get this information.
Look for variations in the way customers value your product or service. Determine whether it is worthwhile or possible to customise your products and prices for different customer segments to increase profits. A product will often have higher perceived value for an 'ideal' customer than it will for an average prospect. How can you spot value variation and opportunities for price customisation? Answer three questions:
- do customers vary in intensity and frequency of use?
- do customers use the product differently?
- does product performance matter more to some customers even if the application is the same?
Assess customers' price sensitivity. What is the price elasticity? Will a 1% change in price trigger a 2% change in quantity?
Identify an optimal pricing structure. Determine whether to price the components of a product or service on a stand-alone basis or as a bundle. Consider whether to offer quantity discounts or bundle pricing.
Consider competitors reactions. Ask yourself how any change in price will affect competitors? What will their first thoughts be when they see the change? What would (or could) you do if you were the competition? And can you respond to that action effectively? You must also consider the overall impact of your pricing (and your competitors’ reactions) on profitability in the sector as a whole.
Monitor final prices, realised at the transaction level. Other terms and conditions can impact profitability, no matter how considered your pricing decisions may be. Discounts for early payment, volume rebates, rebates based on prices charged to others and negotiated discounts should all be analysed to assess the pricing programme and its bottom-line impact.
Key accounts may demand product customisation, just-in-time delivery; small order quantities etc. At the same time they enjoy extended payment terms, negotiate the price aggressively and take discounts that have not been earned. Strategic accounts frequently get more than they pay for. Weigh up the costs and the benefits of having these accounts or start charging a premium.
Understand your customers' emotional response. Balance the long term effects of any emotional response from existing customers and the short-term economic outcome. Use simple market research procedures to assess customer reaction in terms of both perceived fairness and likely purchase intention.
Analyse whether future returns will be worth the cost to serve. Particularly when reducing prices, remember that price erosion may render the market unprofitable.
An effective pricing process will not be created or implemented overnight. It is as much an art as a science which may require some trial and error. This does not mean it cannot be achieved – understanding each of the elements that affect your products and your market and staying on top of the process can help your business maintain or grow market share, secure a price premium and improve market share.
*ICAEW members and non-members can join the ICAEW Finance and Management Faculty to keep up to date with our regular publication, webinars and events.