Pricing is one of the most important decisions a business owner can make.
But what are the major influences on pricing decisions? What factors should you consider when deciding prices?
Here’s the answer.
The 3 Major Influences on Pricing Decisions are:
- Customer’s Willingness to Pay
- Competitor’s Pricing
- Costs
But it’s not enough to simply know what the major influences on pricing decisions are but also why they are so important.
That’s what we’ll cover in this article.
What is a Pricing Decision?
A pricing decision is the set of processes that a business follows to decide what price to charge for a product or service.
Pricing Decisions are often affected by environmental influences.
These include the customer’s perception of value; their ability to pay; their willingness to pay; changes in demand and supply; costs of manufacturing, production, storage, shipping; strategic moves by competitors; currency exchange rates; changes in laws and regulations; inflation and government interventions and subsidies.
Taking all these factors into account can be both challenging and daunting. Yet it is critical to get your Pricing Decision process right because a wrong pricing decision can not only hurt your business and it can take a very long time to recover from it.
The importance of a Pricing Decision
Your Pricing Decisions will drive revenue for your business, affect the growth (or lack thereof) of your customer base, and help you to achieve profitability in various market landscapes. And so, the importance of a Pricing Decision cannot be understated.
A wrong Pricing Decision could hamstring you and lead to a difficult business environment in the future.
Pricing decisions are usually difficult as you need to find a price that will maximize profit while still being affordable for your customers.
You don’t want to charge too low and leave money on the table. Nor do you want to charge too high and lose customers to competitors.
Many of the environmental influences we’ve seen in the previous section are out of your control – eg. currency rates, regulations, and demand & supply. All you can do is react to these external forces.
So, in this article, we’ll focus on the 3 influences on pricing decisions that matter the most and which are still within your ability to influence.
What are the three Major Influences on Pricing Decisions?
Here are the 3 Major Influences on Pricing Decisions that you will face in your business:
1. Customer’s Willingness to Pay
2. Competitor’s Pricing
3. Costs
Customer’s Willingness to Pay
Your Customer’s Willingness to Pay will be influenced by what they can afford and what they consider to be a good value for their money.
For example, if your customer base only has $100 to spend on new shoes – even if you’re selling the world’s best sneakers, it’s unlikely that they will be willing to shell out $200 for them.
The Customer’s Willingness to Pay will also depend on what features they find appealing or beneficial (or not), what price point seems fair for what they’re getting, what your competitors are offering, and what other companies in your industry charge for similar products or services.
If customers think that what you offer is priced high compared to what your competitors provide for the same value, then it may not make sense for them to purchase from you even if there’s pent-up demand.
But if what you’re offering has more value than what competitors are offering, then maybe some customers will accept a higher price point for your product. This is where the concepts of Price Elasticity and Law of Demand come in. You need to find out how much can you raise the price before demand starts to drop.
The bottom line is this:
If your customer just isn’t willing to pay more than the amount you are asking for, and you decide to remain firm on price, you could stand to lose the customer.
There’s nothing wrong with pricing a product high and losing some customers. You may choose to segment your market based on price and only target customers who are willing to pay more. That can be a perfectly legitimate marketing strategy.
But just be aware that your pricing, no matter at what level you set it, will be heavily influenced by your target customer’s willingness to pay.
Competitor’s Pricing
No business operates in a vacuum.
Your business too operates in a live marketplace where different forces like your customer’s willingness to pay and what alternatives they offer will greatly influence how you decide to price your own product or service.
If there’s high demand for what you’re selling but multiple companies are selling the same thing, what price do you choose?
To help answer this question, it’s important to know what your competitors are doing, what their prices are, and what strategies they’re using (such as discounts or bundled pricing).
If your competitor’s pricing is much higher than yours and at your current price you’re making a decent profit, then you could steal some of your competitor’s customers away from them.
On the other hand, if you discover that for a comparable quality product or service, your competitors are charging way less than you are, then the tables could be turned, and your competitor could steal customers away from you.
At this point, whether to undercut them completely or to ignore them and stick to your prices (and potentially risk losing customers), is a strategic decision you will have to make. But you can only make this decision if you know your competitor’s pricing.
If you aren’t sure how to do that, here are some tips on how you can find your competitor’s pricing.
Costs
The third major influence on pricing decisions is what it costs to make and distribute your product or service. This includes the cost of materials, labor, shipping & transportation fees, marketing expenses for advertising campaigns, etc.
If you’re just starting out with a new business idea (or re-launching an old one), determining at what price point you can be profitable can seem challenging.
What you want to do is price higher than what it’ll cost you for production and distribution, so that even if things don’t go as planned or there’s a lot of competition, your business still has the potential to turn an overall profit.
Also note that while your input costs will impact your pricing, your pricing can also impact your costs. This is because your chosen pricing will affect the product decisions you make. And product decisions can (and will) in turn affect your input costs.
So, the relationship between pricing and costs is reciprocal. Use it to your benefit by finding the right balance between the two.
Summary
Three 3 major influences on pricing decisions are:
1. The customer’s willingness to pay
If you price your products way over what the customer is willing to pay, you will never sell anything.
2. Competitor Pricing
If you price your product way more than a competitor with a comparable product, you will lose customers to the competitor.
3. Your total costs
And if you price your product way more than your total costs of building and marketing the product, eventually you will run out of money.
So, all three of these factors are important when making pricing decisions, but what’s most important is understanding why they are so important.
The “Why” will help you gauge the impact that these factors will have on your business so that you can accordingly adjust your marketing and competitive strategies.
Finally remember, business isn’t always about maximizing profit – sometimes it’s also about staying competitive and keeping your business afloat for the long run.