Pricing strategy is one of the easiest levers CEOs can pull to increase revenues in their company. For instance, retail banks can raise interest rates (the price they pay customers for depositing funds at the bank) to quickly attract new balances and acquire new customers. They can then lend out this money at even higher interest rates to corporates and individuals to make a profit.
But here is the thing about pricing – getting it right is extremely difficult. Pricing is sensitive and companies are not always successful in implementing changes. Getting it wrong can be extremely costly.
Consequently, consulting firms have people specialized in helping companies get pricing right. Therefore, you are likely to come across pricing problems in your case interviews. So let’s step through a helpful framework for pricing cases.
Pricing Strategy Case Framework
Consultants tend to look at four areas when they work on pricing projects with clients. Showing your interviewer that you know about the concepts laid out below will set you apart from other candidates.
1. Cost-based pricing
The first option to price a product is to look at how much it costs the company and then to set a price by adding a markup so that the company earns a certain profit margin on each unit sold.
For instance, if you own a coffee shop and buy coffee beans and paper cups from your distributor for $1.50, you might decide to sell a cup of coffee for $2.50, which means that your markup is 66.6% (ignoring fixed costs like machinery, labor and rent, which should partially be allocated to every unit sold).
Here are the typical questions you need to go through for cost-based pricing:
- What are the variable costs for the product you are pricing?
- What are the fixed costs for the company (e.g. rent, staff, utilities, etc.), and how much of the fixed costs should be allocated to the product you are working on vs. other products?
- How many units of the product does the company expect to sell yearly?
- What markup do we want to achieve for the product?
2. Value-based pricing
The second approach companies take to set prices is called value-based pricing. It purely focuses on how much customers are willing to pay for the product and completely ignores costs.
The luxury fashion industry often uses this approach. For instance, Gucci sneakers probably cost less than $200 to manufacture, but the company has managed to build a brand that makes some people willing to pay $1,000 for the shoes.
Here are the typical questions you would ask to figure out value-based price:
- What segment of the market are we planning to sell the product to (e.g. luxury)?
- What’s the next best alternative to the product we are offering (e.g. other similar luxury shoes)?
- What features make our product better than the next best alternative (e.g. superior after-sale service, Gucci brand, etc.)?
- How much are people willing to pay for these additional features?
3. Competitor-based pricing
Finally, companies sometimes use competitor-based pricing for their products.
A recent example of this is UberEATS and DoorDash in Canada. Both companies are currently ready to price below their actual cost and below what customers are willing to pay in order to be the cheapest and win a bigger share in a growing market.
Here are a few questions you would look at when doing competitor-based pricing:
- What other products can customers buy instead of ours (e.g. DoorDash if you are UberEATS)?
- How much are our competitors charging for these products (e.g. 15% service fee)?
- Can we afford to price at the same level as our competitors? For how long can we sustain losses before shareholders revolt or we run out of funds?
4. Overall strategy
Finally, the pricing of a product needs to be aligned with the strategic objectives of a company. Going through the following questions is therefore also very important:
- What’s the objective of our pricing strategy? Is it to win market share, increase profitability, etc.?
- Are there products we can cross-sell / upsell that we should consider when pricing this specific product (e.g. cross-sell mutual funds when selling a savings account)?
- Can we sell different versions of the product that differ in terms of quality, functionality, aesthetics, packaging, availability, or branding so that we can increase sales volume by appealing to more customers or increase profitability by selling at different price points (e.g. Samsung Galaxy S10 vs Samsung Galaxy S10 Plus)?
- Based on these strategic considerations, and the three approaches to pricing that we looked into, what should the price be?
Conclusion
There are three approaches consultants use to think about pricing: cost-based pricing, value-based pricing and competitor-based pricing. Being aware of these tools is important. But what’s even more important is to understand that pricing is usually part of a broader company strategy. You should also customize the framework as much as possible to make it relevant to the problem you are trying to solve.
Jason Oh is a management consultant at Novantas with expertise in scaling profitability for financial institutions.
Image: Pexels
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