All you need to know about the key points of a pricing strategy
Price optimization is an essential part of a company's commercial strategy. Knowledge of the market is essential, but it is not enough when it comes to defining the prices of your products. Many factors come into play, including: the purchase price, the margin, the fixed costs, the competition and the economic situation. The company's performance and profitability are thus the subject of a detailed analysis that will determine the pricing strategy to be implemented. This analysis leads each sector involved to a reflection on the pricing policy to be implemented in order to satisfy consumers and increase the company's performance at the same time.
Consumers' perception of price
The company's goal is to sell its products quickly and to bear the cost of their immobilization as little as possible. The cost of immobilization means:
- storage in the warehouse;
- the financial immobilization of the goods;
- the delay between the payment of the supplier's invoice and the actual sale;
- the possible loss of value of the product due to a prolonged immobilization.
It is a question here of fixing the selling price in a very precise way. This action leads to an efficient stock rotation, and therefore to regular sales, allowing the company's cash flow to be restored and, in the long run, to make a profit. The notion of customers' price perception comes into play at this level.
The perception of the price of a product depends on several factors inherent to the product. The product must:
- please the customer;
- meet his expectations;
- be essential to them;
- be well positioned compared to the competition;
- inspire confidence;
- have a price adapted to his budget.
The last point can be an obstacle to the purchase, especially for online sales where the customer will systematically look for the best price for a given product.
Composition and determination of the selling price
The company determines its selling price according to different criteria added together that form the market price. First of all, there is the purchase price. The company's purchasing department is constantly looking for the best possible discount depending on the quantities purchased and the supplier's offer. To this purchase price are added the direct and indirect fixed and variable costs, the company's margin and the VAT borne by the end customer.
Determination of direct and indirect costs
Adding a percentage margin on the purchase price before tax is the easiest way to find the selling price. Nevertheless, the company's pricing strategy must integrate direct and indirect costs:
- operating costs (storage, electricity, heating);
- workforce costs (warehouse storage, order preparation);
- distribution costs (delivery and transport);
- advertising costs (marketing and website).
The calculation of these costs is generally computerized, by a calculation based on the sum of these costs brought back to a copy of the product.
The company must first calculate the cost of the product. This is the sum of direct and indirect costs divided by the quantity of products in stock. Thus, for 10,000 copies of a product and 50,000 € of direct and indirect costs, the cost price of each copy is 5 € (50,000/10,000), to which we add the purchase price of the product. This amount will allow us to set the minimum selling price of the product, without the company losing money (the break-even point).
Addition of the company's margin
As part of its pricing policy, the company then sets a profit margin to be applied to the product. This margin is determined according to the line of business, the prices charged by competitors, seasonality, supply and demand.
The margin is defined as the selling price minus the VAT, the purchase price of the product and the cost of production. The margin, also called gross operating surplus, allows the company to pay its financial expenses (loans, in particular) and then to generate its net profit.
Application of the selling price on the product
Once these previous elements are determined, the selling price can be calculated. It is composed of the purchase price, the cost price, to which we add the margin and the VAT. It is therefore easy to understand that the determination of the pricing influences the amount of the company's margin. The company determines its pricing strategy by finely adjusting the margin cursor on the final selling price.
This pricing strategy is therefore based on all the costs incurred by the company. We will see that there are other possibilities for calculating the selling price that should also be taken into consideration.
Competition-based pricing strategy
The company evolves in the world of competition. If this competition is never harmful, it implies the implementation of a pricing policy that is completely different from the one based on the costs borne by the company. The way to set the selling price is to look at the prices charged by competitors, on three levels:
- level 1: analysis of a given product and comparison of two identical products;
- level 2: study of a range or series of products and analysis of the prices of a sales sector;
- level 3: comparison between all the products of competitors and those of the company.
The study of the competition makes it possible to know the reality of the market and to see if the intended selling prices are really different from those of the main competitors. In the case of a similar product, where the planned selling price is close to the competitors', the pricing strategy is therefore effective, since it is in line with the other players in the sector.
In the case where the price considered is higher or lower than the prices charged by the competition, several questions need to be asked.
- Has the break-even point been properly calculated?
- Is the purchase price competitive?
- Does the cost price take into account all elements, including variable overhead?
- Does the product provide a clear advantage over the competitor's product?
- Does the competitor's or the company's reputation affect the pricing?
- Is the quality superior or inferior?
- Does the quantity purchased correspond to the negotiated quantity discount?
This set of questions must provide a reliable answer to validate the selling price. Depending on the answers provided, the company will then determine the marketing actions to implement and the way to assert its positioning compared to the competition.
Learn about dynamic pricing
Introduced a few years ago in the pricing strategy, dynamic pricing presents solutions to improve pricing performance. IT and artificial intelligence come to the rescue of companies and management teams, by updating the sales price in real time. This dynamic pricing is based on different elements customized to the company's needs:
- number of searches for the product on search engines;
- immediate analysis of competitors' prices;
- cost evolution;
- relationship between supply and demand;
- market variables.
This innovative way of managing pricing undoubtedly improves the company's pricing performance. The introduction of artificial intelligence reshuffles the cards of the pricing and price management policy of the company. All data is entered into the dedicated software or platform. Various settings of company-specific parameters are then applied before an optimized selling price is given.
This price takes into account the company's margin, which is weighted according to direct and indirect costs, the cost price, the purchase price and the position of the competition on a similar product. This type of sales price prediction is perfect for e-commerce solutions. The pricing position is continuously studied by the artificial intelligence integrated in these high-tech tools.
Call price policy and pricing positioning
The call price consists of offering a very attractive selling price on a given product. Sometimes the product may even be sold at a loss. The purpose of this strategy is to attract the customer and to present him with other products that are sold at fair value. The selection of loss leader products is usually done after a hard negotiated purchase price and a concession on the commercial margin.
Usually presented on the first page of the website or at the top of the shelf in a physical store, this product is used as a lever to sell other references. The company accepts to see its profitability decrease temporarily and uses this means to boost its other sales.
To conclude, the company's pricing policy is not based solely on a simple margin rate applied to a product. If this method has been widely used in the past, the era of artificial intelligence, sales predictions and optimized price calculations now gives each commercial sector the possibility to combine profitability and commercial performance by taking into account supply and demand.