As all business owners know, to be competitive in the marketplace, organisations need to produce products that offer superior value to their customers at a reasonable cost.
Calculating the right price point for goods and services can be a complicated process since there are many variables to consider.
When determining a business pricing strategy it is important to understand how price elasticity affects the products demand curve.
Price sensitivity increases when the market is saturated with homogenous products or when there are numerous product substitutes to choose from. As a result businesses need to offer unique and differentiated products to maintain a competitive advantage. To differentiate the product effectively, businesses need to have a rich understanding of their customers’ values. This information can assist businesses in developing a product offering that has unique attributes which are highly valued by their customer.
Many buyers may be willing to pay a higher price if they can justify the additional expenditure. Some customers believe that a higher price implies a superior product. To limit the affects of price sensitivity businesses can market their product to segments that value quality or prestige. Sales for prestige products may increase as the price increases.
If an organisations product is a necessity for example, medication, the pricing will be less sensitive because buyers need to buy the product regardless of the price.
To gain insight into how changes in price affect product sales, businesses need to look at their historical sales data. Analysis of the relationship between fluctuations in price and quantities of units sold can give businesses an understanding of the affects of price elasticity on their product portfolio. Alternatively, businesses could monitor fluctuations in the quantity of good sold during sales promotions or fluctuations in the quantity of goods sold ad different price points in similar regions.
Many businesses mistakenly believe that a high mark up equates to high profits. However, a product at a high price might discourage customers from buying. Especially in a marketplace saturated with many competitors and product substitutes. Even if a business has a high mark up, they cannot make much money if only a few customers are buying their products. Holding inventory costs businesses money and it ties up capital. So in a lot of cases a high mark up can lead to low profitability. A better approach is to focus on the organisations total profits.
By increasing inventory turnover businesses can improve total profits. Businesses may often need to reduce mark ups to increase turn over. If a product is highly price sensitive small reductions in price can result in the sale of a larger volume of goods. However, the accumulated smaller profits from a higher sales volume can equate to a high value of total profits.
Determining the optimum price point for a product is a key factor in maximising profitability. The best price for a product will often lie within a narrow range. Charging too much will lead to a lower volume of sales, charging too little will mean lower profits.
Written by Alan Tollemache,
Located on the North shore in Sydney, Alan offers accounting and bookkeeping and business services to help organisations achieve their goals. For more information visit:
www.accountant-bookkeeper.com.au
