The Art of Pricing

The art of pricing involves analyzing a complex set of variables. And pricing can be circular with the products or services being offered.

For example, when offering a product or service one can determine the price that customers are willing to pay. However, the price that customers are willing to pay affects how the products or services are developed and offered.
For now, let’s avoid the circular argument and focus on how pricing is determined given products or services that have already been developed.

First, Products or Services have very different pricing variables and should be handled in very different ways. Pricing for services involves looking at the time horizon to determine costs and margin opportunities. Fixed costs, perishable inventory as well as variable demand in different customer segments all need to be considered to maximize profits at a point in time. Also, service pricing can have an available capacity element that needs to be factored into the pricing equation (also known as Revenue Management).

Product pricing has a longer time horizon than service pricing, so the pricing variables are somewhat different. Inventory is less perishable which means opportunity costs are lower. However, carrying costs can be higher and direct cost to manufacture may be higher as well compared with pricing a service.

A basic pricing model is as follows:

1. Given your product or service, identify your target market
2. Segment your target market into as many groups as possible. This could be by gender, age, location, time, social groups, etc.
3. Determine your demand and available products or services for each segment.
4. Price your products or services according to each demand segment. Different segments most likely have a different willingness to pay. This could be done by offering student or senior discounts, matinee prices,
   seasonal promotions (Mother’s Day, back-to-school sales), new product launches versus older products, weekend rates, etc.
5. Track your revenue, sales, and lost opportunities and use that information to go back and refine your demand forecast for each segment.
6. Refine your pricing in a continuous feedback loop.
   

I have touched at a very high-level different pricing attributes to consider in this introductory article. In the coming weeks, I will discuss more specific examples of demand and how to determine and set prices.