Figuring out your market profitability is the cornerstone of running a sustainable business. The financial health of your business is measured by profits rather than revenues. For profit, as the guru of gurus Peter Drucker once declared;” Is not the purpose of a business, but rather the test of its validity.” But to be profitable, you need to understand what profit really means and where it comes from. A good place to start is to work backwards to where pricing lies.
Setting an initial pricing strategy is the single most critical decision you will ever make to launch your new business venture. Regrettably there is no magic bullet for setting prices. Still, a committed preparation and doing your homework help you get to the right track towards achieving your worthwhile destination - your profitability. This preparatory stage comprises 3 pivotal factors: first, is a thorough knowledge of the cost components of your product from the ground up to its delivery; second, is knowing your customers and non-customers in your industry and grasping their pain points; third, knowing your competition and how to go beyond it to create preference for your brand.
The difficulty to price a product to eventually cover costs and bring revenues is what brings startup businesses to a halt. The venture capital CB Insights pinpoints pricing as one of the top reasons startups fail. Such aspiring entrepreneurs pay so little attention to a marketing element that is their top-line revenue. They attribute their failure to price to either sales force who doesn’t know how to sell the benefits of their product and offer price concessions instead of selling value. Another excuse for failing to price is because of competition that started the downward spiral of slashing prices. Competition, so they always say, started these price wars and “if we don’t react, we will be eaten alive.”
Strategy is simply how to compete in order to reach your destination. In this pricing context, we need first to select our pricing objectives. Maximizing your profits is not the sole pricing objective. Other objectives may include enhancing your product image, providing customer value, obtaining an adequate return on your investment by generating cash flow, and maintaining price stability in your market. More importantly, your pricing objectives must be consistent and aligned with your overall marketing objectives. You might have more than one pricing objective but you have to prioritize them.
Pricing strategies comes after selecting your pricing objectives. An astute startup is to pursue either one of 3 pricing strategies according to the objective selected. At one extreme, you have a penetration strategy. You price your product at a low price to dominate the market share. You might even go for a free-revenue model like what Facebook does. Facebook has built its billion-dollar empire without charging its users a cent. On the other hand, they made revenues from advertisers who are willing to advertise on this highly-viewed social media.
At the other extreme of the pricing strategy is the skimming one. Upon launching a new technology that is unmatched in the marketplace, you set high prices to maximize your profits. Sony and Apple are two best examples of market skimming. When Apple sells its latest iPhone at the highest prices, it addresses an upmarket segment of the market – a sufficient number of buyers who are interested in keeping abreast of the latest in technology. The higher price communicates the image of a superior brand that attracts superior customers and makes competition irrelevant.
A third and moderate pricing strategy is maximizing current revenues. You are here filling demand in the market rather than creating one. Your obsession is on the present moment and how to get cash flow to keep your business moving. Because filling a demand is easier than creating one, competition seeks to maximize their day-to-day revenues through price concessions. To find a foothold in this competitive space, the players may sacrifice long-term gains by ignoring the effects of other marketing mix variables.
Pricing is a critical driver of every startup’s business profitability. No other element in the marketing mix has more impact on profits than what pricing does. The unconscious habits of running promotions and slapping rebates are but symptoms of a deeper problem - which is: the unwillingness and inability of business owners to study pricing and keep on honing this skill that is conducive to profitability in the short term and sustainability of their businesses in the long run.