What price?

When considering your marketing mix a crucial component is price.  From a marketing perspective price is a measure of what a customer will exchange for the benefits of a service or product. Price can also shape the perception of quality in a customer’s mind. Wine is a great example of how price can shape perception. The more expensive the wine the better the quality – right? There was once an experiment where two identical wines where placed side by side. The labels where hidden so as not to bias the tasters. The wine tasters where told that the wine on the left cost $20 and the wine on the right cost $100. Before they tasted the wine they were asked which wine they thought would be superior. Without exception they chose the $100 wine. Then they were asked to taste the wines and report which wine was superior. Again, the group chose the $100 wine with many audibly expressing their great pleasure in drinking a $100 wine. Remember, the two wines were identical and only had a retail value of $20. Such is the power of price.

So how do you set pricing? There are a least five different pricing options as follows.

Cost-based pricing: This approach focuses on the businesses cost structure. The goal is to ensure the price covers all fixed and variable cost of producing and selling the product or service. One important aspect of cost-based pricing is to understand your break-even point. One way to calculate break-even is:

Break – even point = fixed cost/unit sell price – unit variable cost

Profit-based pricing: This approach targets a desired dollar amount or percent return on products or services sold. To target a particular profit you may need to calculate required volume. This can be done as follows.

Volume needed = fixed cost +target profit/unit sell price – unit variable cost

Demand-based pricing: This approach considered the demand of a product or service. How elastic is the price and what would customers consider as fair.

Competition-based pricing: This approach determines price based on the competition.

Value-based competition: This approach considers the value in use of the product or service. This is driven by market research and customer perception. A product may be very cheap to produce but be of such benefit to the customer that a high price can be set which reflects the value. A product or service which is rare may also fall into this category.

It is important to understand how to set your pricing because pricing is the only component of marketing which produces revenue. All other marketing factors cost the business money. Managers often struggle with this and make mistakes which impact on their financial objectives. I mentioned earlier how pricing can shape perception and so managers must also understand the segmenting, targeting and positioning (STP) strategy of the business. Is your objective just to survive; do you want to maximise profit; or do you want to increase market share?

To determine to correct price of a product or service a strong understanding of your market is necessary. Questions relating to the size of the market, consumer characteristics, competitors, marketing spend levels, channels of distribution and availability of substitutes must be considered. Further analysis using models such a “Porters Five Forces” are useful to determine the attractiveness of the market and what pricing can be sustained.

In the end, the final decision about pricing is determined by the market place. You can use customer surveys and the like to determine customer perception but the real information comes from your sales demand, profit figures and market share. A final piece of advice is don’t take your eyes off your competitors. Know what they are doing at all times and understand how they react to your price changes. Don’t get into a pricing war unless there is a clear competitive and strategic reason for it. Pricing wars generally only cap the profits for everyone and is unsustainable.

Tony Grima

http://www.percego.com

Setting a sales budget

A sales budget is a crucial factor for any business and is the foundation for all other budgets. It acts as a method of control and planning and provides a roadmap to achieve financial objectives and allocate resources.

Many businesses have trouble with setting a sales budget because it often relies on forecasting. Depending on the type of business there is enormous pressure to get the budget right and failure to do so can have significant impact on the business. Think about a manufacturing firm which needs to import rare raw materials with long lead times for its product range. Incorrectly setting the sales budget will impact on inventory levels and other operational factors such as labour. Underestimating the number of units sold will leave the manufacturer unable to meet demand, and due to lead-times, unable to obtain the materials quickly. Underestimating the sales budget impacts equally on labour requirements. Due to unplanned demand the manufacturer may need to quickly employ and train more personnel, assign additional shifts or purchase more equipment. These are activities which cannot be achieved overnight and the result may be loss of customers, contracts and reputation. Of course, over estimating sales budgets creates similar problems which will impact on the business.

As sales forecast are the basis for setting the sales budget, how is this done given the variability of markets and not having the benefit of a crystal ball? Well, it’s not an exact science but is based on several factors as follows.

• Past sales volume
• Economic conditions
• Market research information
• Pricing policies and their impact on demand
• Marketing
• Quality of sales force
• Customer feedback and data
• New and existing contracts
• Competition and availability of substitutes
• Seasonal variation
• Unfilled backlogs
• Gut feeling (yes, that’s right!)

There are a number of approaches to forecasting sales but I will consider just two

1. Macro approach – Forecasting total sales
2. Micro approach – Forecast sales by product, service, customer, territory or salesperson.

The macro approach is based around a mathematical model which identifies the relationship between variables and company sales. The model revolves around statistics to measure these relationships. An example may be a driving instructor school and the benefit to them of knowing how many learners permits are issued per year. Another example is a buildings products manufacturer. They would be interested in how many building and development applications are approved by local councils. Another method which rides on the macro approach is to forecast sales based on your market share. If research indicates that your business operates in a 20 million dollar market, and you have 10% of that market, then a sales budget can be estimated. I would be wary of too much reliance on this method. The statistics could be wrong or your market share can be impacted by new competitors and products or simply changes in buyer behaviour.

The micro approach relies more on internal company information such as feedback from customers and the sales team. Tools such as a CRM are invaluable in this regard. The weakness of the micro approach is the bias of people making the predictions.  The sales team may be too optimistic with their expected pipeline and customers may give inflated figures to negotiate better pricing. A method to guard against bias is to record actual results against predicted results over a long period of time. This allows management to make the necessary adjustments to sales forecast.

Tony Grima