elitefts™ Sunday edition
Is Your Pricing Legal?
Before We Get Started
Before I begin this post, I’d like to point out that these are strategies I’ve seen used, read about, studied, discussed and heard about from others. These aren’t necessarily what we use at elitefts.com. One very important aspect to understand about pricing is that some strategies are illegal and unethical. They can have negative consequences or even put you out of business. At the same time, they can make the difference between a successful product and a flop. The purpose of this post is to educate you as to what some of these are so you can make more informed decisions.
You can compete on three things: price, quality and service. Recently, some have even added education and technology to this mix. You can’t have the lowest price and the best service. You also can’t have the highest quality at the lowest price. Financially, this can’t be done regardless of the economies of scale. You have to select what one or two you want to compete on and stick with it.
Product Life Cycle
When pricing an item, the first thing to consider is EVERY product has a life cycle.
You’re pricing strategy should consider all phases of this process. This is true if it is a product, specific service, seminar, or program you are offering. Before digging into different strategies, there’s one consideration above all others…
Your product must be worth what the consumer is willing to pay.
You may think your service and time is worth $1,500 per hour, but if nobody pays it, your time is worth zero in the consumer market.
What goes into the price of your product?
You need to account for more than your COGS (cost of good sold) but all expenses associated with the business. Will this be a product or service that has a high exchange rate? How much will it cost to service? Will commissions be paid? How much inventory space will it take up? Are there affiliates? What is the start up cost? Is the product influenced by prices that shift (gas, shipping, steal, and other materials)?
Rather than list all expenses, take a look at your Profit and Loss statement and look at the expenses closely. Determine how they will be influenced by the sale (or lack of sales) of the particular item. While you’re at it, look at your net profit very close. This is where the real value is. Determine the most important expense ratios associated and use them in your decision making process.
If you’re billing for a service and price by the hour, are you factoring in the prep time it takes for this hour? Travel? Materials? Etc. These are all things that have to be considered. You don’t want to find at the end of the month that you are working for free, or worse yet, in the negative.
Here is a list of some pricing strategies I’ve seen used over the years.
Skimming Pricing – This is usually done if you have a very short supply of an item and it will only be around for a small time. The technology sector is usually where you see this most. Technology changes so fast that today’s new item is almost worthless a year from now. These items have a very short product lifecycle, so the pricing needs to reflect this for the manufacturer/retailers to be able to get a profitable ROI.
Penetration Pricing – For this to work you need to know (or be very sure) that the product will have a long life cycle. With this strategy you will price the item very low to penetrate the market and gain market share. BEWARE that this is one of the biggest causes of death in business because at some point the prices need to come up to have margins large enough to sustain and grow the business. If this strategy is used, it is highly recommended that you have other streams of income that will cover all of your expenses. Rarely will your margins and sales be what you predict. This is also one where you need to pay particular attention to your federal and state laws because if you don’t do this “fairly” you could end up in jail.
Loss Leader – This strategy isn’t used as much as it was years ago because it lost its luster and people have caught on. Years ago, if your local retail grocer puts soda on sale for lower than they pay, people would buy a few 12-packs and pick up some other things. Because of this, they were there making the total cart a positive profit margin. In today’s economy customers will show up and fill their carts with soda and that’s it. They will buy nothing else and by the time they get out of the door, their cart carries a negative value and the store just gained some great goodwill, but lost their butt in the process. This is also one of the biggest negatives with Groupons right now. They are great for customers, but when 600 people show up for their free ice cream cone, the store just lost all their profit for the week.
Psychology Pricing – This art is growing more and more every year (month). Neuromarketing is something anyone in business should be following closely, as it will and is becoming the future of marketing. Picking a price that is more “attractive” than the alternative (psychology pricing) is one small aspect of this. We all know $19.99 looks better than $20. We ALL know it’s still 20 bucks, but if the price is listed as such, many would not buy. Price perception is extremely important, so consideration needs to be paid to it.
Bidding – Most people reading this won’t have to deal with this situation, but many companies will need to bid on contracts and this requires a completely different strategy than any other. Without going into complete detail on this one, I will just say the best strategy is if you find yourself in a bidding position and your margin becomes too low to offer the quality and service you’re known for – PULL OUT OF THE DEAL! There will always be those who jump on these just to underbid and get the job for bragging rights, to pay off debt, to get over a hump, or several other reasons that have nothing to do with profit. Don’t get caught up in a deal that could cost you time and resources for little to zero return. If you’re a trainer, think of the client you trained for peanuts because the guy down the street quoted a much lower price. How did that work out for you?
Price Discrimination – I’m listing this one because I see it with top trainers all the time. They will charge their professional guys and/or celebrities a much higher price for the exact same service. Personally, I feel this is a horrible policy, but it is a strategy that’s being done every day. This is another one that isn’t legal, so if this is a strategy you’re using, I’d suggest doing more research. Find a better and legal way to go about doing this.
Cost Plus Pricing – This is done by setting the price based off the cost and a set profit margin. Many companies know exactly what margin they need to get to stay in business and remain profitable. As this can change over years (expenses go up), the policy is still the same. Many that don’t use this type of policy will find it to hard to forecast what their net profit will be during critical times and/or shifts in product category sales and seasons.
Elasticity – You must know if your product line(s) are elastic or non-elastic. In some cases it doesn’t matter if the item ever goes on sale or is promoted because it will sell regardless of the situation, customers or price. It will, however, still follow the same product life cycle. Demographics, patents, exclusivity and strong branding can play a large part in this.
Competition Based Pricing – This is pricing based on similar competitor-based products and it’s one you need to be careful with. It is important to know how your price compares in the market, but you don’t know what pricing policy the other party is using or their expenses. Some examples, Company A may have a lower price because they have larger buying power and move more products. They may also have lower expenses allowing them to sell at lower margins. The trainer working out of a gym for little to zero rent or commission will have a lower price than the one who has their own studio, staff, rent, advertising, marketing, etc. If the studio owner tried to match the price offered by the other trainer, they’d be out of business. Your price needs to differentiate based on quality, service, education, ascetics and branding.
Manufacturer Suggested Retail Price – This is the price at which the manufacturer asks you to sell the product. Most of the time these can’t be trusted, especially in the supplement industry. These numbers are usually very inflated to make the buyer (the retailer) feel that they are getting a better margin. In these cases, it is best to do your homework and see what others are selling the product for before you set your list price. While I’m not 100% sure on this, it is illegal for them to demand you to sell a product at a particular price. At the same time if a price is requested, it is proper etiquette to honor this and if you do need to clear inventory and sell at a lower price, make them aware first. Communication is very important in situations like this.
Market Pricing – This is when the pricing is based on market research, focus groups, surveys, etc. This is used more by larger companies, but in my opinion is no better than any of the other pricing strategies.
Premium Pricing – Setting the price of the product or service artificially high to encourage favorable perceptions.
“My lawyer is $1,500 per hour.”
“My trainer charges $300.00 per hour.”
“I paid $8000 for my training and diet program.”
The general perception with this is, “WOW! These services must be really good to demand that type of price.” The problem with this one is you need to appeal to the demographic who is willing to pay this and you better be worth it (in their perception). If not, you will have zero business.
Decoy Pricing – This is when one price (or product) is set high to make the others look more affordable. This can also be accomplished by setting one price very low to make it look “cheap” thus making the others appear as a better deal. This is seen in almost every industry across the board. If you want your most expensive service to look more attractive (your one-to-one training rate is $200), then set up a new service that will be $400 hour. Now $200 doesn’t look as high as it did when it was your most expensive product. It is important to also note that there are many people who DO want the best and most expensive option so this is not truly decoy pricing. Make sure you set the price at a reasonable point for the high-end buyer.
Predatory Pricing – Price artificially low until all the competition is gone, and then jack the prices back up. This is similar to Penetration Pricing, except the price is set at a VERY low price to kill competition. Once this is done, pricing gets jacked up. This one can also land your ass in jail.
Collusion Pricing – Sometimes leaders in an industry will get together to decide on the best price for their product or service. Once again, another one that will land you in jail.
Term Pricing– This is an often-overlooked component to pricing with respect to terms. Profits are good, but cash flow is even better (the topic of cash flow will be for another day). Eight percent margins on someone who pre-pays is often better than a 10% margin on someone who pays in 90 days. The flipside to that is that you may be able to significantly increase margins by providing looser terms. Whether this is actually a sound business decision or not, will depend on if the higher margins justify the additional time and reflect the value of money you are extending. It needs to be adjusted for the added risk you are taking by extending those terms.
This is probably more than you wanted to know about pricing, but if you have been following Under The Bar for some time, you know I take great pride in being a meathead and want to help others become better in their training, work, business and life. This way we can be well-rounded meatheads.
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* One set hitting the triceps from every angle you can think of.