Economists describe it as opportunity cost. Budding entrepreneurs often consider it a simple “cost plus margin” calculation. But for new businesses dipping their toes into the water for the first time, or established firms that are looking to expand product lines, setting profitable prices requires a lot more thought.
While entrepreneurs are often busy with day-to-day operations, many overlook the importance of setting an effective pricing strategy for their products and services.
“It’s easy to make assumptions, especially in China,” said Mark Hedley, Asia business development and research manager for B2B International, a market research firm. “But companies need to take time to research the market fully.”
Price setters need to first consider the dilemma of balancing competitiveness with profitability.
“One of the first questions to ask is, ‘Do we want to capture the money first, or penetrate the market with low prices?'” said Fan Oswald-Chen, a Beijing-based managing director of Simon-Kucher & Partners, a strategy and marketing consultancy.
Finding the right balance is crucial. Setting prices too low at the beginning can endanger long-term profitability, as customers are likely to become reluctant to hikes once they are used to a price.
In addition, companies need to have a clear understanding of the product they are going to offer, and how it should be positioned in the market. Thus, Hedley stresses the importance of market research. While a lot of general information can be found on the internet – especially competitors’ websites and industry reports – speaking to industry experts and stakeholders is also useful.
Businesses can also utilize a marketing tool called “conjoint analysis,” in which a pool of potential customers is presented with various different price and value combinations for a product. “By pooling these results, businesses can calculate the optimum pricing for a particular offering,” Hedley said.
All companies must factor China’s vast regional diversity into their decision-making. Income levels and the value placed on certain products can vary widely across the country.
For example, greater competition in first-tier cities can push prices down, according to Hedley. “China always needs to be seen as many, many markets,” he said.
Pricing experts also recommend using due diligence processes when talking to third parties. Entrepreneurs who attend trade fairs or similar events, for example, may be given advice by so-called experts on doing business in China that isn’t necessarily accurate.
“These people may have their own interests here, and so they may not give a clear view of the pricing level,” Hedley said.
To avoid such issues, check and screen the companies and individuals you work with, and always obtain a second opinion to get an impartial view of the market.
Thorough research of close competitors is another vital tool in the research process. However, Oswald-Chen stresses that firms should not focus too much on competitors’ pricing; what is right for one company is not necessarily profitable for another.
Companies should avoid rushing into a market and aggressively under-cutting competitors with unrealistically low prices. It is generally more profitable in the long run to build partnerships with loyal customers, as opposed to targeting short-term transactions with consumers who are only interested in small savings.
“It’s important not to de-value the product. If a genuine need for it has been identified via market research, then typically it is possible to charge a premium for that particular product,” Hedley said.
Being open to discounting is helpful as well, particularly in a market like China. While market trends tend to set prices in Western countries, Chinese consumers often assume that businesses offer discounts.
Setting the right prices also depends on the competency of sales teams. When sales representatives meet with potential clients for the first time, they usually do not come across chief decision makers. As such, buyers at lower managerial levels often seek internal profit margins. Price setters therefore need to factor in an extra level of profit margin to win the sale.
Even when a business is up and running, and products are starting to sell, the pricing process shouldn’t stop.
Bosses need to ensure that an explanation of price strategies trickles down to employees. Sales workers in particular must fully understand how and why prices have been structured, so that they can be confident in communicating the value of their products to customers.
Oswald-Chen adds that pricing strategies needs to be periodically revisited. “Some of our larger clients have admitted to us in the past that they don’t know how the original pricing strategy evolved.”
She noted examples of companies that made sweeping price reviews for all products, such as implementing a 2% increase across the board. This can have a negative effect as different products will have varied market penetrations.
Finally, Oswald-Chen advises businesses to not be too rigid in their approaches. “Having a comprehensive pricing strategy is more important than following a strict process to devise it,” she said.