Factor to Consider When Developing a Pricing Model.
By Laura Patterson is president and co-founder of VisionEdge Marketing, Inc.
Thursday, 27th November 2014

As marketers flex this analytical muscle they are able to develop a variety of models "  from marketing mix to attribution, from segmentation to pricing;

We’ve been involved in a few pricing model conversations lately and thought we’d share some key points.

Higher profitability targets, greater competitive pressures, and the emergence of new technologies are all impacting a company’s approach to pricing.  

Why is pricing important? A McKinsey study found that a 1 percent change in price could result in an 8.6 percent change in profitability.  The company found that pricing can have a greater impact on the bottom line than just reducing costs.

For example, a 1 percent improvement in fixed costs generates only a 1.7 percent increase in operating profits, while the same 1 percent improvement in variable costs (including raw materials, labor, etc.) begets a 5.9 percent rise in operating profits.  As a result many organizations have asked us what factors to use in developing a model that is right on target.

Unfortunately the most common pricing strategies are often not a very good approach. In a survey of its members by the Professional Pricing Society, 30 percent of respondents said they priced new products by mirroring their nearest competitors, and another 22 percent set new-product prices to recover costs and tack on a profit.

Only 18 percent said they did customer research to determine the value of the product or service to potential customers. And when it comes to Internet pricing, 40 percent said they simply mimic the pricing of their offline sales channels, and 28 percent responded that they don’t have an Internet strategy at all.

So what is the ideal pricing strategy? You want to develop a strategy that will capture the value of the product or service for a particular customer or customer segment without putting the brand at risk. 

Your pricing strategy should take two marketing activities into account:  price formulation and price execution.  The price formulation is the development of the strategy, tactics, guidelines and policies and should be driving by pricing objectives, production costs, customer demand, competitive behavior, and environment factors (such as price regulations and the state of the economy). 

The pricing objectives should be derived from your corporate objectives.  If the corporate objective is to increase net profits by 10% per year over the next five years, then a strategy will need to be developed to increase profitability.  The strategy might be to grow market share by introducing new customer-request features into a product with a pricing objective to maximize profit for this new product.

What factors should go into building your model?  First, as a market-centric company, you would take customer behavior into account to build your pricing model. 

Other factors you will include in your model are end- benefit (the relative value or need for the product), differentiators (the special features or services that distinguish the product), substitutes (the availability of alternatives), price expectations (historical pricing for this type of product/category and competitive pricing), price-quality perception, relative size of expenditure, any shared costs, and the competitive behavior your competitors’ are likely to take in reaction to your pricing strategy. 

Once you have formulated the pricing model, you will need to address price execution which involves capturing, configuring, and institutionalizing the strategy.

Laura Patterson is president and co-founder of VisionEdge Marketing, Inc., a recognized leader in enabling organizations to leverage data and analytics to facilitate marketing accountability. Laura’s newest book, Marketing Metrics in Action: Creating a Performance-Driven Marketing Organization (Racom: www.racombooks.com ), is a useful primer for improving marketing measurement and performance. Visit: www.visionedgemarketing.com  

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