Ever wonder why certain products and services go up in price over time while others go down. Realizing that this happens and understanding why can provide your business a strategic advantage in better anticipating revenue, competitive. and margin-impact changes.
Many people believe pricing changes are primarily driven by supply and demand. Supply goes down, demand is stronger and prices go up. We read about this and witness this every day across many industries. Just look at the price of oil that has had big swings up and down tied to the control of supply and reactions to demand. While supply and demand does impact pricing there are other factors to consider.
Think about products you buy today that same or similar products cost less a few years ago. How about food products, office supplies, or the price of a 1st class stamp? These products have gone up over the years and while there might be some adjustments down over the long hall prices have gone up. Now look at the price of computing. Not only have the prices come down but the performance of the products has gone up exponentially.
While it might be difficult to control pricing trends, understanding the drivers of pricing will help you manage to margin targets, control supply of products and services being sold, and better anticipate market trends to your advantage.
Factors to consider:
- There is an emotional and subjective aspect of pricing trends. Believing pricing will go up or down based on history will drive pricing trends. This occurs in both the consumer and commercial segments.
- Believing that better products or services will replace the currently available product will drive pricing down over the life of the product or service regardless of the cost of manufacturing the product or the cost of delivering the service.
- Competitive undercutting – Competitors wanting to enter a market or increase share can drive price points down artificially.
- Dominant market share – Dominant market share regardless of why (might be driven by lack of competition) will allow for higher prices
- First to market advantage – Getting to a market first with a new product or service will allow you to set price points based on your goals of share and margin. Consider that while you might be the first to enter the market you won’t be the only player for long. Your understanding of pricing drivers and impact short and long term matters.
- Brand dominance – a powerful brand might help command higher pricing and less discounting. Competition will need to lower price to attempt to gain share. Think Apple.
- Uniqueness – products that are unique and possibly personalized have a greater likelihood that pricing will go up over time. Consider pieces of art, low product automobiles, etc.
- Products/services in which the primary factor of cost is labor – This excludes labor services where efficiencies through technology and automation can be used to lower the effective cost. Consider labor for services like heating/AC repair and auto repair. As labor costs go up so do prices assuming margin is to be retained. Typically we’ll see industries in this category have flat to slightly higher prices with margin erosion over time.
Industry pricing policies need to consider competition from other areas. Pricing high simply because you can while positively impacting your bottom line, might open up the door to competition outside of your industry which can lead to what is referred to as disintermediation. This tends to happen as the cost to deliver the product or service differently allows for companies to make money in different ways. Just think about how internet commerce has changed the way people shop. The ability to price shop in a matter of seconds across hundreds of retail businesses has changed the impact of pricing on perceived value. Additionally companies like Costco, Dell, and Apple’s iTunes have driven industry pricing changes through implementation of efficiency models and what you buy developed outside of their respective industries. Prior to iTunes you had to buy the entire album or CD to get the 1 or 2 songs you really wanted.
Complimentary products or services can also drive the price points of your products and services. Consider the price of fuel and the related impact of the price and discounting of SUVs and trucks. You always have to look beyond your product and service to the companies and industries that compliment and enable your product and service to work.
Understand where your products and services fit, what the pricing drivers are, tendencies in the market, and the impact to your brand. Work on the things you can control that affect price and factor in the ones you can’t. As you enter new markets or re-frame existing ones consider not only the trends of the opportunities around growth and maturity but also the factors that drive pricing. Your decisions around how to compete might very well be altered.