What are some good pricing strategies?

Pricing

The following FAQ was written and generously provided by npEnterprise Forum subscribers, Jennifer Li Shen and Way-Ting Chen, of Blue Garnet Associates.

What is pricing?

Where do I start with developing a pricing strategy?

How do I determine how much prospective customers value my product or service?

Are there special considerations when conducting market research for a social enterprise?

Should I price lower than competition to attract new customers?

What happens if my social enterprise’s product or service costs more to produce than my competitors?

What are some common pricing strategies?
How can a nonprofit, in good conscience, follow a premium pricing strategy?
How do I get different customers to pay different prices?

 

What is pricing?

Price is the dollar amount your customers pay for your product or service. Pricing is more than a number: it is the process of monetizing your social enterprise’s value in the marketplace. Pricing helps define your social enterprise’s profitability, which has implications for the rest of your organization. At its core, good pricing strategy will reflect your enterprise’s overall marketing and business strategy.

Where do I start with developing a pricing strategy?
Since price directly affects revenues (price x quantity sold = revenue) and, therefore, profitability (total revenue - total costs = profit), a good place to start when developing your pricing strategy is by determining your unit costs. But don’t stop there – pricing strategy should reflect the value of your product of service to your customers.  For instance, are your customers coming to you for a commodity-like item that competes on price (e.g. a bran muffin)?  Or, is providing a subsidized service a primary value of your offering (e.g. below market rate rent in a nonprofit multi-tenant center)?  Or, are customers coming to you for a high quality, premium product (e.g. hand embroidered textiles from women-owned microenterprises in India)?

How do I determine how much prospective customers value my product or service?
This is where market research is critical – the best way to determine how much prospective customers will value your product or service is to ask them. The tricky part is: asking someone directly how much they will pay for a product or service is not an effective way to predict actual consumer behavior. A customer might tell you, in theory, that he will pay $5 for your product, but, in reality, when he goes to the store, he will be comparing your product to many other similar products. Thus your market research – done in the form of surveys, focus groups, individual interviews, store visits (as appropriate) and/or secondary research – should involve asking customers about what and how much they value particular attributes of your product or service, how much they actually have paid for similar services/product, as well as looking at your competitors’ prices and products.

Are there special considerations when conducting market research for a social enterprise?
Market research involves trying to gain insights into prospective customers’ core values and beliefs – important information as you develop your marketing strategy (remember, it is not enough to just offer great product features, you will also have to communicate these features to your prospective customers).
It may be the case for your social enterprise that your customers’ values and beliefs are of utmost importance because you are selling them a product/service with great emotional value – you are selling a product PLUS a mission. Thus, determining whether or not you can charge more for your social enterprise’s product will involve asking prospective customers how much they value your mission vs. other features (quality, design, convenience) that your competitors might be able to match or exceed.
In some instances, your social enterprise may be targeting customers who are sold based on the quality of your product/service, coupled with a pricing structure that reflects the fair value in the market.  The mission or social cause may be less valued by your customers.  Market insight into what your customer is looking for will aid in your understanding on how to price.

Should I price lower than competition to attract new customers?
It largely depends on your marketing strategy – are you doing this to match a competitor’s pricing?  Or to penetrate a new market?  Or to expand market share?  Always try to consider your product or service’s true value to the customer before lowering your price.  If you deliver higher value to your customer, if you can communicate that value to prospective customers, and if you have evidence to support it (generally through market research) you should charge higher prices.
Pricing strategy based on what you think your competition is doing can lead to a “price war,” and lower profitability for both you and your competitor. For example, if you believe that your costs are lower than your competition’s costs, you might decide to price lower than your competition. However, you could be wrong – your competition’s costs might actually be close to your costs, and your competitor might lower its price to match yours. Even if you are right, there is no guarantee that a new competitor won’t enter the market who can match your costs (and price) by copying your business model.  Game theory is a way to understand the longer-term effect of lowering, or for that matter increasing, your price – e.g. “If I do X, my competitors will do Y, therefore I chose to do Z in anticipation of Y, and on and on.”  
Finally, another consideration in lowering your prices is the permanency of such a decision.  In some cases, you may be able to restore pricing in the future.  In others, this level becomes the new “market price.” If so, what impact will this new price have on your social enterprise or organization’s profitability?  Is it sustainable? 

What happens if my social enterprise’s product or service costs more to produce than my competitors?
For a social enterprise, determining costs is not always straightforward – it is important to account for both “social” costs incurred (e.g., extra training needed for employees for an on-the-job-training program, using environmentally friendly materials, etc.), as well as conventional “business” costs (e.g., salaries, raw materials, etc.).
At the end of the day, this means that a social enterprise’s product or service might cost more than a conventional business’s product or service. This is not necessarily a bad thing – it all depends on the dynamics of the market and how customers (or funders) value your service or product. It might be that funders value your social impact, and therefore are willing to pay for your “social” costs, whereas customers only value your product for its conventional features, so you can only charge them enough to cover your “business” costs. Some social enterprises follow a hybrid model where consumers value the mission and are willing to pay a premium to cover some of the “social” costs, with funders covering the rest.   It depends on the market of the product/service you are offering – Is it highly competitive? Do you have a monopoly? Etc.
A strong implication is that you are able to understand, delineate and manage your costs along “social” and “business” lines.  Clarity around “social” costs is especially important in communicating with your funding community – many funders may believe that your nonprofit does not need the funding because you are earning income.  At the same time, managing your “business” costs is critical for success in a competitive market.  If your social enterprise’s “business” costs are in line with those of your competitors, you avoid a situation where your competitors have a competitive advantage over you.

What are some common pricing strategies?

There are many pricing strategies, but here are a few that you are likely to recognize:
Premium pricing – This is a familiar strategy of offering special features and benefits to a sub-set of customers who are willing to pay more for them. You can either follow a premium pricing strategy relative to other products you offer – think about business-class vs. economy seating on airplanes – or relative to your competition – think Starbucks vs. McDonalds coffee.
Price bundling -- This is a tactic of offering several products for one price in a “bundle” to customers. Individually, a customer might value each product differently, but together, she will pay a premium. One example is café pricing – you might price soup for $3 and a sandwich for $5. Price bundling might involve offering a soup & a sandwich for $7. A customer who likes both soup & sandwiches, but doesn’t think each is worth the price you are charging individually, might still buy the combo “deal” for $7. If you didn’t offer the combo “deal”, he might only buy the soup for $3. Thus, by bundling, you encourage your customer to spend more at your café.
Complementary pricing – Similar to above, but, in this case, you charge rock-bottom prices for one good, and then a premium for a complementary good. For example, you may attract consumers to your café by offering $1 lattes, but then tempt them with $3 gourmet biscotti.
Penetration pricing – This involves offering customers a low price (sometimes below cost), generally early in your enterprise’s life-cycle. The theory behind penetration pricing is that, over time, your enterprise’s costs go down (the more you do it, the more likely you are to become more efficient at manufacturing your good or offering your service, or the price of technology or raw materials might go down), and thus, you will eventually become profitable. This strategy can be used if you are introducing a “new-to-world” product, and you believe that, by the time any competition enters the market, your costs will have gone down (thus you can afford to have lower prices than your competition).
Experience pricing—This is similar to the above strategy in that you offer customers a low-price (sometimes below cost) to try your product. However, in this case, it is a one-time discount: you want new customers to “experience” your product because, once they try it, they’ll be “hooked.” Another way of accomplishing this is through giving away free samples.
“Cost-plus” pricing – Those that have negotiated government contracts might be familiar with a term “cost-plus” pricing, which involves taking your total cost (fixed + variable) per unit and adding a % mark-up, which is supposed to represent a “fair” margin. “Cost-plus” pricing is easy to calculate if you know your true costs, but there are many problems with this approach – it is akin to pricing in a vacuum, and ignores the most important question of the product’s value in the marketplace (competitor’s pricing, value to consumers, opportunity cost, etc.).

How can a nonprofit, in good conscience, follow a premium pricing strategy?
Managers of social enterprises may be conflicted about following a premium pricing strategy, knowing that, by doing so, some of the very people they are trying to otherwise serve with their larger mission will not be able to afford their social enterprises’ products or services. Yet, some social enterprises lend themselves to premium pricing strategies, as they are generally offering something more than “just” a product or service – they are offering a product or service PLUS a mission.  This presumes that if you are in a highly competitive market you can successful differentiate your product/service and properly segment and reach your customers (e.g. premium-priced holiday cards from UNICEF with focused distribution at outlets to reach targeted customers).
If a premium pricing strategy makes sense for your business, but you still want to insure that lower-income individuals will be able to afford your products and services, you likely want to follow a common strategy called “price discrimination”. True, this sounds ugly, but it is nothing more than getting different customers who value your products differently – or, in this case, have different abilities to pay – to pay different prices.  Coupons distributed to targeted segment for discounts may be one method to pursue (more below).  

How do I get different customers to pay different prices?
There are many different strategies for accomplishing this, but you should keep in mind that you need to show demonstrable respect and concern for both segments of your customers – you don’t want your customers willing/able to pay more feeling as though they are not being treated fairly any more than you want your customers unable to pay more feeling the same way.
Coupons/discounts – Offering your clients or certain community members discounts or coupons for your products is a simple way to make your products affordable to a subset of customers.
Sliding scale – Many nonprofits have incorporated a sliding scale based on income into their pricing strategy. When using this tactic, you have to take into account how much effort you can put into enforcing the sliding scale, since income is difficult to verify. One good example of this tactic is a tax-preparation clinic for low-income individuals which charges below-market prices on a sliding scale – in this case, verifying income is easy.
Periodic discounting – This is a traditional retail concept – think about the post-Christmas sales. In this case, price-sensitive customers will attend your sale (even though you are selling goods far in advance of the season when most customers think to buy: say, bathing suits in December), and customers who can afford it will wait until a more convenient time to shop.
Second market discounting – This is an increasingly common strategy for manufacturers who have excess capacity – think outlet stores. This is best done when there is some geographic distance between your store and the second market store – you don’t want your customers who are willing to pay more going to your second market store.