Whether You Know It Or Not, You Have A Pricing Philosophy - But What Is It?

All pricing processes should start with an understanding of your pricing philosophy. This is different to your pricing strategy, which we’ll cover in a later article; pricing strategies depend on factors such as product/service quality or on levels of competition.

So what’s a pricing philosophy?

Let’s start with a question. What do you sell?

Perhaps you’re thinking about a particular product that you offer to your customers, possibly something that you make yourself or alternatively something that you resell. Or maybe you’ve said it’s a service, such as hairdressing or accountancy.

It’s really a trick question. In reality, we all sell one of three things: inputs, outputs or value.

Inputs are the things that go into whatever you’ve sold.

The classic example of this is professional services, such as solicitors, who usually sell time - if it takes 5 hours to do something and they charge £200/hour, then you pay £1,000. If it takes 6 hours you pay £1,200. They might say they are selling expertise, but when they charge per hour then they are packaging that expertise as an input.

Any company that uses a cost+ approach to pricing is also just selling inputs. Imagine a manufacturer, they add together the cost of raw materials, cost of labour, overheads such as R&D, utilities, admin, and then add a margin on top. But the price they charge just depends on those inputs; if costs go down, prices go down, if they go up then prices go up.

It’s just the same for retailers - cost of goods, plus wages, plus the retail space… plus a margin.

Outputs are the things you sell.

If you base your prices on what the competition is charging then you are simply selling outputs. Ok, maybe you charge a premium because your product or service is better, or maybe you charge a little less because you have a cost advantage, but if your prices go up and down as your competition’s prices go up and down then you are just selling the ‘thing’, whatever it is.

This is true for professional services too. Solicitors might charge a fixed fee for property conveyancing, or accountants might charge a fixed fee for end of year personal tax returns. If that fixed fee depends on what the ‘market’ usually charges then you are selling outputs.

If you are in a highly commoditised market then almost certainly you are selling outputs.

Value is the difference you make for your customer.

You’re basing your price on the value you have created, and that value can be tangible (for example, you can measure the additional profit your product or service creates for the customer) or intangible (for example, it might be how it makes them feel).

For many years Apple’s iPhone was the most profitable smartphone on the market. When they launched they didn’t simply add a margin to the material cost; they didn’t price match other smartphones on the market at the time. They looked at how desirable it was, how it made users feel, how much easier and pleasurable it was to operate, how much more productive users could be. And they charged a premium for that value.

So how do you use this?

We’ll get into the detail of deciding on prices later, but the reason we start with a review of your fundamental pricing philosophy is because this is all about how you think about pricing.

Some companies simply never consider the value element at all. I once worked with a flooring retailer who wanted to go online, and worked with their team to decide on a set of prices based on a combination of what the competition charged, what their service levels were, and what they did differently to their competitors - a combination of outputs and value. And then the MD drew a line through everything, and said ‘we add 25% to that range, 20% to this range’, and just worked through the list reducing the prices. Giving margin away. Because he simply did not think in any terms other than inputs.

Recognising how you currently approach pricing gives you the chance, if you want to, to change that approach to one that gives you higher margins.

You don’t have to have a single pricing philosophy for everything you do. You might have different approaches for different channels, or for different products or services, or for new product launches compared to existing products.

For example, one client of mine is in a highly commoditised distribution market where the only decision customers make when choosing a supplier is ‘who can offer the lowest price?’, so all pricing is based on inputs. The client knows the minimum margin they need to achieve, so they quote that price, and if they are lucky they get the sale. But to service the market they have developed certain competences, and they can use those competences to add considerable value to a different market - where they can use a value approach.

So before you decide on a price, stop and consider about what you are doing. Are you unthinkingly using one pricing philosophy without considering the options?