Previously I have mentioned that customers don’t care about costs, they only care about products or services that meet their price points for what they desire. However, costs are an important part of any company’s marketing strategy. And there are many different types of costs. It is important that a company knows how to understand their cost types so they can develop the proper marketing techniques to offer their products or services.
It is very typical for a company to want to cover its long-run average costs and often such companies will set prices high to cover those costs, but that can actually be detrimental to revenue and profit growth. When looking at average costs you must remember that 50 percent are greater than the average and 50 percent are less than the average, so using average costs completely misses most of the customer’s price points. And there is no such thing as an average customer! So why use averages? Averages are used by companies for reporting purposes and looking at trends, and should not be used for pricing. If you recall the article on Segment Pricing then we should use Segment Costing when determining how to price to different customer segments.
Below I have developed a chart that defines cost types over a time horizon. Costs are time sensitive and that determines how these costs should be applied when pricing products or services.
Time horizon sensitive
– Variable costs
– Fixed costs
– Sunk costs
– Opportunity costs
– Marginal costs (Incremental costs)
– Long-run average costs
Non-time horizon sensitive
– Direct costs
– Indirect costs
– Allocated costs
– Out-of-pocket costs
– Activity-based costs
Whether you work in a service company or a product company it is critical that the cost types are understood by those making pricing decisions. And it is also critical that the employees are empowered to determine which costs to apply and how to negotiate prices with customers based on the time horizon of the services or products being offered. I will not define these cost types here because they are readily defined on the internet. My intention is to provide a classification based on the time-sensitive nature of each cost type.
With many different types of customer segments, and many different types of costs, the Pricing & Revenue Management department should focus on monitoring the revenue received from different customers segments to make sure the company maintains a healthy position.
In the coming two articles I will explain how Segment Cost Types are used to maintain a balanced revenue mix as well as how to prevent a maturity mis-match from occurring due to a lack of visibility from management’s decision making.
Three Tree Solutions 