Pricing 101: Why is pricing important?

After reading chapter 10 on price promotions in Byron Sharp’s book, “How Brands Grow”, I was inspired to share some of my learnings while studying Pricing Tactics & Strategy (one of my favourite subjects) at UTS. In this article I will highlight some of my thoughts on why pricing is important.

At university marketing students are taught that price is a component of the marketing mix. Price can be defined as a number of monetary units a customer has to pay to receive one unit of a particular product or service.

Pricing correctly is the fastest way to grow profits and requires a calculated balance between one’s willingness-to-pay and the perceived value for a product/service.

We know that most businesses operate with an end goal to obtain profits and we know that pricing is a powerful variable, which has the ability to directly affect a firm’s bottom line. Despite the importance of pricing, it still remains one of the most undermanaged and misunderstood functions. Hence, why pricing is a top concern for many marketeers and business owners.

Pricing is increasingly important because:

• Increased market competition, rivalry and price promotions can results in unfavourable price wars. An example of this could be seen between Woolworths and Coles as they compete for the lowest priced milk.
• Lower consumer loyalty means switching between brands is easier and more prevalent.
• Better informed consumers make more price comparisons and cherry pick goods. For example buying a camera at one store then buying other components at different stores.

In another book “The Pricing Advantage” the authors Barker, Marn and Zawada assessed the income statements of 1200 global organisations and revealed how rapidly the right price can generate profit. In this study, when prices were indexed to 100, it found that fixed costs averaged to 20.5% of the price, variable costs accounted for 68%, and profits at 11.5% (figure 1). Given the assumption that volume and both fixed and variable costs remained constant, a 1% increase in price dramatically increased profits by 8.7% (figure 1). When we compare a 1% improvement between fixed costs, volume and variable costs, it is clear that reducing variable costs by 1% increases profits by 5.9%.

 Small price improvements = huge increases in profits

Figure 1: Prices indexed at 100 and the broken down components (left) and a comparisons of profits based on a 1% improvement in fixed cost, volume, variable cost and price factors (right).

We can clearly see why effective pricing is an important function and driver of growth which requires critical strategic evaluation to maintain market competitiveness.

Further Readings:

Baker, W.L., Marn, M.V. & Zawada, C.C. 2010, The Pricing Advantage, 2nd edn, John Wiley & Sons, New Jersey.

Sharp, B. 2010, How Brands Grow: what marketers don’t know, Oxford University Press, Melbourne.