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Price is worth a thousand words: Getting it right

Price is worth a thousand words: Getting it right

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Published by Manoj Nakra
Pricing, retail
Pricing, retail

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Published by: Manoj Nakra on Jul 18, 2010
Copyright:Attribution Non-commercial


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A Price is Worth a Thousand Words: Getting it Right Introduction The importance of the correct pricing is critical because getting

closer to the right price has significant impact on the bottom line. For example, for a company with 8% profit margins, a 1 % improvement in price translates into a 12.5% jump in net, if volumes remain unaffected. The business community in the Middle East, particularly distributors and retailers, occupy a small segment of the value-chain from the manufacturer / brand owner to the customer, and has traditionally followed a cost-plus approach to pricing i.e. retail prices are set by taking a suppliers price list and multiplying by a factor to achieve a targeted gross margin, a margin that covers costs and achieves a targeted return. This approach has historically worked because of the underlying monopolistic structure of the markets. Middle East markets are highly competitive based upon the complete freedom to do business, but the underlying structure of these markets, that influences how firms compete, is one of supplier-monopolies, based upon exclusive distributor and franchise arrangements of the brands. The cost-plus approach, where the selling price is fixed, and revenue is an outcome of units sold, may not be the best approach to maximizing the business opportunity. Cost-plus pricing is based upon the assumption that all relevant competitors have the same cost structure, the products are undifferentiated, and gross margin is a good measure of profitability. The reality, however, is that those competitors can have vastly different cost structures; the products are not commodities but are differentiated based upon brand names, features; and, gross margin alone is not a good indicator of profitability. The range over which a supplier can set prices varies between the cost of the product and the perceived value of the product in customers eyes. A customer purchases a product only if the perceived value is greater than the purchase price (i.e. customer has a surplus), and therefore a supplier’s endeavor is to set a price where the consumer surplus is adequate to motivate a purchase (i.e. customer is getting a large enough surplus), and is simultaneously well above the cost to give an adequate return. The concept of perceived value is a qualitative concept, and the real challenge of pricing is that the suppliers do not always know the perceived value of a product from the customers’ point of view. The goal of pricing is for a supplier to differentiate the unique customer value in its product or service, and then extract the greatest value possible from the consumer without compromising sales. Research suggests that managers are usually well informed about the costs of providing products and services to customers, and also well aware of the theoretical or designed value provided by the product and its features to consumers, but, are inadequately informed about how customers actually evaluate their products (i.e. are the customers able to appreciate the intrinsic value in the product). Managers are also uncertain about how customers may respond to price changes (i.e. what impact price changes may have on consumer’s willingness to pay). To set best possible prices we need to understand the


meaning of price, the role it plays in the purchase behavior of a consumer and how price is interpreted by consumers. The purchase process Let us try to unravel the process of buying a product at a retail store, which we all have experienced. As we enter a store, touch and feel the product, we reach conclusions about its price and quality, two perceptions that are inexorably linked. As we assess the product quality, we also form an opinion about the appropriateness of the product price. It could even be the other way round. A higher price tag may also be inferred as an indicator of the product’s higher quality, propelling us to search for product attributes that support (or deny) the perception. A product’s price, therefore, has two meanings - one, of what needs to be given up (price paid) to acquire a product, and second, an indicator of quality. A high price could increase our willingness to buy the product based upon a perception of higher quality, and simultaneously reduce our willingness to buy based upon the greater payout required. And conversely a lower price may increase our willingness to buy based purely upon price, and concurrently reduce our perception of product quality, reducing our interest in buying the product. The gap between the divergent perceptions based upon price and quality, when quality is higher than price, is the perceived value of the product. The final decision to purchase the product is based upon comparison of price as a surrogate of value against an internal ‘scale.’ What is this internal scale? In our shopping trips we have often experienced an intuitive reaction to a price of a product being either fair or unjustified or a bargain. The reaction is based upon a fact that we, as shoppers and consumers, have over time developed a subjective internal rank ‘order’ of competing products on a price scale that we use as a benchmark to reach conclusions about the price of the products that we encounter on shopping trips. For example, when we see a price of a basic white oxford button down shirt of brand ‘X’ at Dhs. 295 and feel the price is high, we reach the conclusion by comparing the price against our internal benchmark that says the price should only be Dhs. 225, the price in London. What this implies is that in the buying process we implicitly evaluate the value of the product and the fairness of the price - is the perceived value of the product / service being acquired reasonably large as compared to the price being paid, and is the actual transaction price within the customer’s range of expected price or is the supplying firm over-charging? If at any stage of the buying process we have any ambiguity about the value that we are getting or the fairness of the price then we exercise any of these options – we can either find a less expensive option, or visit a competing store to compare features and prices, or delay the purchase till the product is on promotion or be forced to buy the product if no other choice is available. An informed purchase decision, therefore, requires much more than just price information. We also need to know the prices of other similar items to confirm (or deny) our perception of the correctness of the price, the prices of other stores for the similar items to assess the fairness of the price, and what the prices might be in the future. The language of Price


Since price is a decision that a company takes, and it is an important external variable that influences the value perception and purchase process, it is, in addition to the personal experience with a product or service, the means by which the company can send a message to a potential customer. A company’s pricing policy sends a message to the market by giving customers multiple cues to understand the company’s thinking about the product, its value, the company’s understanding of the consumer, and the type of buying transaction the customer can expect. In an interview published in Harvard Business Review (March-April 1993) Nicholas Hayek of Swatch says, “Price is a mirror for the other attributes we try to communicate…A swatch is not just affordable, it’s approachable. Buying a Swatch is an easy decision to make, an easy decision to live with. It’s provocative, but it doesn’t make you think too much.” We, as consumers, have all experienced some dimensions of this language. When comparing prices of similar competing products, a higher price is often perceived as a signal that the company believes that the product has something superior in its offering (could be product attributes, and / or it serves a niche need better than others, etc.). And if it does believe that it is providing higher value then all aspects of the sale e.g. the ambience where the sale occurs, salesperson-customer interaction, the after-sales service etc., should all reflect that belief. We also receive ‘cues’ from retailers whether a price is high or low, or fixed or variable. Consider a retailer who offers special sales for existing clients by invitation to a pre-view of sale merchandise, which will be advertised only later to the public. The message is that existing customers are more valuable than new customers, and the invitation is a tangible proof of this preference. And if a sales person starts customer dialogue by telling the customer that the price is sticker price less 25%, then the unintended message is that ‘our normal price levels are lower than the nominal sticker prices.’ A sale or promotion every month destroys the perception of validity of the sticker price. And if a discount is in response to a customer request or question, then the message is that ‘prices are flexible for aggressive customers.’ The above examples emphasize that the implicit message embedded in price is prone to be miscommunicated and misunderstood, and therefore the price setting process needs to not only address consumers but also internal company audiences. We need to be sensitive to how the message will look after it goes through various intermediaries like sales staff e.g. will the sales staff explain and justify the price or communicate, often indirectly through body language, the message that the product is expensive. How to price We develop a pricing process that considers both the economic and psychological factors that influence a consumer’s willingness to buy. The goal of pricing should be to set a price that meets the goals of the organization and its suppliers - that of maximizing business opportunity in the long-term while meeting short-term profitability objectives, and then managing the price expectation of the consumers to realize that opportunity.


Step (1) - To maximize business opportunity the starting point of the pricing process will not be the supplier’s list price i.e. pricing will not be cost-plus. Rather it will be necessary to articulate the value that the supplier is seeking to communicate through the brand, product features, and service levels. But in the real world what a company seeks to communicate about a product is rarely what the customer understands. To understand the customers’ appreciation of the product and its value, a dialogue will be needed with the frontline staffs that are in direct contact with customers. The knowledge of customers is usually tacit knowledge embedded in the mind of the frontline staff, and effort will be needed through incisive questioning to make their knowledge explicit. This is a not an easy task since sales staff generally undervalue products, focus too much on the utilitarian aspects of the purchase, are generally less sensitive to psychological and egoexpressive aspects of consumers, and tend to over emphasize price, usually lower price. During the inquisition one will have to be on guard not to accept any information without double checking and direct experience, for which it may even be necessary to be on the shop-floor and sell to a few customers occasionally, and walking the market. Step (2) – Every marketing person is sensitive to the fact that there is no one ‘ideal’ customer or average customer. The universe of consumers is always fragmented into subgroups, each with their unique needs and expectations from products and brands e.g. the way a gourmet cook buys cooking appliances is different from an amateur cook or the needs of a musicphile from audio equipment is very different from a lay music enthusiast. Understanding of customer segments is critical, because apart from identifying products that meet the needs of the varying segments, it also enables identification of segments within the targeted customer base for whom prices can be varied e.g. for the benchmark comparison products, a company needs to be competitive whereas for highly differentiated fashion ranges a different pricing formulae can often work. Therefore companies which follow a differential pricing strategy based upon segmentation and an understanding of varied consumer needs and behavior earn better margins. Step (3) – It is also necessary to make an assessment about customer price sensitivity to high or low prices to predict what may trigger search for alternatives. Many factors influence search behavior like purchase economics, nature of product, brand loyalty, ability to delay purchase, etc. Economic issues, as discussed earlier, encompass the role / value of the product for the customer. A customer buying a product / brand to make a social statement e.g. a Louis Vuitton hand bag is far less sensitive to price. The same customer buying a product for use in the inner confines of the house invisible to others e.g. bed linen, may be willing to buy a generic product as long as it meets basic quality expectation, and be much more sensitive to price. The nature of product, the ease of making product and brand comparisons, and switching effort / cost from one brand to another, also influences the extent of involvement in terms of effort and time a customer is prepared to commit to a purchase. Customers buying computers may shop around understanding features, technology, and after sales service and support of the various brands whereas a rare customer will extensively search for a brand of soap if it is not available when needed. Brand loyalty reduces search effort, whereas a high intensity of competition instigates a search effort based upon perceived difference in the competitive


offerings. In the regional ME markets ability to delay purchase and buy the product on a foreign trip is an option if one is uncomfortable about a product or price. Step (4) – Pricing requires taking into consideration pricing strategies adopted by competitors, and being able to forecast potential responses of competitors to pricing moves. It is necessary to understand the product / brand positioning vis-à-vis competitors. This requires appreciation of competitive position vis-à-vis other brands, identifying the competing brands, and any potential changes in the brands repositioning / competition. Dubai is but a microcosm where the brands compete. At a certain level it is necessary to keep track of international developments like competition amongst brands either at a global level or in the country of origin, emergence of new competing brands, and the role of low-priced generic products in the competitive landscape. Very often appreciation of what is happening internationally enables a local entrepreneur to fine tune the domestic strategy e.g. the emergence of Zara as a major competitor forced competitors to become finer in pricing in the domestic market. For technology products it is necessary to even consider the influence of new technologies e.g. if the product is going to re-structure an existing market (e.g. digital cameras vs. mechanical cameras or plasma / LCD TVs) then developing a new price-product-feature spectrum is necessary to redefine how the products will be re-positioned, and how the price will change over time. This is necessary because the local consumer is savvy, well traveled, uses the net to compare products and prices, and sensitive to world-wide trends. Step (5) - The pricing of individual products will be based upon range of products and their features, and the service levels required to compete in the marketplace based upon segmentation and positioning of specific products versus the competition. The art of pricing requires evaluating the prices from both the company and customer point-ofview. The company requires the target margin to be achieved, which is a straight forward math calculation. In addition to achieving margins it is necessary to ‘manage the price expectations of customers.’ A key question in this era of globalization, access to price comparison sites on the net and frequent travel particularly in the ME, is the price parity of products with London. And this needs to be the first test of pricing. A price of 10 % less than UK prices cum VAT is a desirable goal. Next it is necessary to assess the prices of ‘signpost’ items. Research suggests that customers often use ‘signpost’ items to form an overall impression of a store’s prices. And this impression guides their purchase of other items for which they have lesser price knowledge e.g. if we are buying groceries and note that the price of a six pack of Coke is high, then we start to believe that all products in the store may be highly priced. Prices of signpost items can be used strategically as indirect communication to communicate the price positioning. Signpost items are items that are basic in the product category and serve as pivots for pricing the range of products that fulfill the same basic need e.g. in the small appliance business a basic kettle or toaster can serve as basic items or in the apparel business a polo t-shirt or a white oxford button-down shirt or a blue blazer serve as good signpost items. One needs to be careful in pricing signposts items since consumers are very sharp, and have an uncanny ability to infer when prices have been artificially set or are a result of special circumstances e.g. declining computer prices based upon a general decline in the industry. If signpost items serve as the pivot of the pricing communication, it is also


necessary to assess whether or not the prices of products within a category have a logical and ‘explainable’ progression. At the store level this encourages customers to compare prices of similar products, and understand the thinking behind the pricing, and avoid unfavorable comparison with products that are very different in terms of the value offering. This also often assists in customers graduating up (phenomenon of trading up) to higher priced items. If the price achieved through the above checks is sub-optimal i.e. higher than desirable, then it becomes necessary to develop concurrent plans for other elements of the market mix advertising, merchandising, staff training, promotions, etc. to achieve pricing goals. Step (6) – A key strategy to manage perceptions of price on the shop floor is the need for proper staff training. Communication plans need to be developed focusing upon ensuring that the value perceived by customers is a close as possible to the value as planned by the company, and perceived value is reasonably higher than price based upon an understanding of product positioning vis-à-vis competition. Step (7) – The final test of pricing is the customer. If price is a language of the seller, then it is necessary to access the response of the customer. Organizations need to develop feedback mechanisms to assess why a customer walks away from a purchase intention what is the sticking point in the lost sale - features, service or price, and what are benchmark comparable product / brand those customers speak about during dialogue on the shop floor? Conclusion The process as delineated appears rigorous but needs to be ingrained formally in the thinking process of managers. The benefits arise not only in terms of finer pricing but in always keeping the customer and competitive positioning of the product / brand in perspective forcing the organization to develop actions to counter competition, and realize benefits from the market where competition is weak. This is critical in retail business because price changes are an integral part of strategy to move goods, and inventory turns are as critical as margins to achieve profitability targets. All retailers know that dated merchandise is like granite blocks, immobile. Developing pricing as an organizational capability has three requirements. One, well trained staffs who understand a company’s strategy, range of products, customers and suppliers (so that pricing decisions are not tactical). Second, transparency of actual costs and margins to enable executives to get a better understanding of aligning the prices with profitability. And third, delegation of responsibility to enable the frontline feel responsible for and become sensitive to profitability rather than sales, and developing networks with a cross-section of customers to anticipate and manage customer responses to price changes. Fixing a price requires much more than determining the level at which to fix a price for each product. It is a more systematic approach that needs to recognize the need for decisions in many areas – pricing goals, pricing strategy (what the organization seeks to


achieve through the pricing), price structure, price levels, and managing the role of price in consumer decision making.


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