This tool is used to demonstrate to a client that pricing is different to costing. The five step process brings into focus all the elements of pricing. The pricing tool is a good one for showing your benefit to the firm. It brings a wide range of issues to the table.
Typical Time taken to use:
Allow 30 minutes.
Where to use:
As part of a Marketing and Sales strategy.
General Usage Hints:
You can safely assume that the vast majority of people have their Pricing Policy wrong. Show the consequences of getting it wrong. Price too high and you lose business, price too low and leave profit on the table. The average business person places too much reliance on Competitor price points. There is no certainty that the Competitors are pricing correctly in fact you can normally assume they have it wrong!
Most people know how to cost a product but very few know how to price.
Step by Step Guide
There are five steps. We suggest you write the numbers 1 to 5 in a column on the left hand side of the white board.
1. Write the words Cost Plus next to number 1. Explain that Cost Plus is simply the cost including overheads plus profit, say 10 or 20%. For example: Materials + Labour + Overheads + Profit = Price. Most business attempt to price this way. Too often they get it wrong, usually handling the overheads allocation incorrectly. Encourage discussion on methodology and outcomes of this step. For the purpose of this exercise let's say we have conducted the Cost Plus exercise on a writing pen and the price is $1.50
2. Next write the words Competitor Pricing against the number 2. Repeat the same process at step 1. Lets say the price of their pen works out to be $1.25. Be careful when you assess the pricing between the pens because the competitor may not know how to price and you don't want to follow them up or down in price.
3. Write the words "Demand Based - What the market will bear" (What people will pay for your product), next to number 3 but say that you will come back to it.
4. Write Government Regulations next to number 4. Explain Government Regulations. Does the government regulate the price? Is it applicable or not. If it was Pharmaceuticals for example this may apply.
5. Write Marketing/Business Plan next to number 5. Ask the questions "Am I going for Growth", "Am I going for profit" or "Am I going for both". Most businesses try to hedge their bets and go for both. A difficult outcome.
6. Go back to step 1 and spend time brainstorming the factors that people use to make the purchase decision. Make sure your costing is right. Is there any room to move? Can you outsource or look at activity based costing?
7. Now go back to step 3. Conduct a Product Benefits Analysis. For our pen example we used in the 'Benefits' area of the Product Benefits Analysis the range of colours, ease of use, availability and fit for purpose. In the 'Products' area we inserted our name first and then the names of our competitors and their pen.
8. Look at the scores. You have scored your product against those of the competitors and can now see what price your product can demand due to its relative score. What do the scores suggest in terms of pricing levels. For example, if you scored 50 out of 100, and competitor A scored 65, their current price is $1.25 per pen and your Cost Plus price is $1.50 per pen, you obviously have a problem.
9. To resolve this situation you do the following:
Recheck the Cost Plus price. Can we make any savings?
Review the Competition Scores. What score do you need to get to justify $1.50 per pen?
What action plans will be required to achieve the target score?
10. Review all the five steps. Show how this process can drive strategy. Suggest that this review is done on a formal basis at least once per year. Make sure you are involved in the review process. Remember the Pareto Analysis where 20% of your products give you 80% of your sales. Use this methodology to test all of your products/services. Pricing is a key problem for most organizations. Set a strategic price, one that will maximize your sales. Deduct the profit and you are left with a target cost. Cost reduction and strategic partnerships can be used to meet or better the target cost.