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Marketing I, Pricing Strategy: Part XIII of "Learnin's From My MBA" Series


This series takes concepts learned in an MBA program and adapts them for easy comprehension by scientists without a management background. This is currently the 13th part of the series and the sixth in an introduction to marketing.

When we introduced marketing several months ago, we discussed the four most important facets of marketing: Product, Promotion, Pricing, and Distribution. These famous "four p's" of marketing (the "p" in distribution is hidden) intertwine and form the basis for a successful strategy for selling your product. In the last few installments of this series, we tackled product strategy and promotion strategy. This week, we take our first look at pricing strategy.

Pricing strategy is the most underestimated and most misunderstood part of the marketing mix. Even expert managers, who have been selling products for years and who have mastered the other three elements of marketing, often misjudge the effects and power of a consistent pricing strategy.

The error most people make is that they base their price on what it costs them to make the thing. "Hey, we can crystallize people's proteins, and it only costs us about $200 in equipment. Let's charge double that! We'll make a fortune!" That's the logic a lot of people use, and they almost always incorrectly pick the optimum price. The second most frequent error is "It costs us $200, and the competition is charging $500! We can take away all their clients and make a fortune if we charge $400." Well, in a perfect market, where every customer knew everything, that would be fine--people would know exactly what your product was, could compare it perfectly to the competition, and base their purchase on the best value. But the world isn't a perfect place. In a world of imperfect information, one of the most frequently used indicators of quality is price. The crazy thing is, charging more for an item may give it the perception of higher quality.

A fantastic example of how powerful pricing strategy really is can be found in your everyday lab supply purchasing. Take the blender, or "liquid homogenizer," as they're often called in scientific instrument catalogs. You'll find the same Oster blender that you can buy at Wal-Mart for $30 in just about any lab equipment catalog. Usually, they'll cost about $120. Well, the first thought that goes through most people's heads isn't "Hey--I'm getting ripped off! I should just go to Wal-Mart." Instead, it's "They must be different blenders. I'm sure the one for the lab has a better motor, or something. If I buy the Wal-Mart blender, it'll just break down." The fact is, they're exactly the same blender. But the price has given you the perception of quality.

A great example of pricing strategy being used brilliantly comes out of the Bausch and Lomb contact lens scandal. It turns out this company was selling two identical contact lenses at two completely different prices. They were selling "daily disposable" contact lenses at about $5, while selling the exact same lens as their extended wear lens, for about $60. It caused a huge scandal, but, when you think about it, who would trust an extended wear contact lens that only cost $5? And who in their right minds would pay $60 for a disposable?

So choosing a price that's too low can be just as damaging to your sales than a price that's too high. In the case of the protein crystallization company we used earlier, believe it or not, a lot of clients will choose the company charging $500 over your $400 product. Their reasoning will be "This is too important. Let's not mess around with a cut-rate company. Let's get the best." Even though it's probably exactly the same service being offered.

OK, so we've looked at two ways that are just plain wrong for determining price. So, how do you determine it?

The first and most important thing is that your pricing strategy should be consistent with the rest of your marketing mix. If your promotion strategy includes marketing based on "lowest price in the industry," you should of course have a pricing strategy that's consistent with that: If your only selling feature (promotion wise) is that you're cheaper than the rest, and it turns out you aren't, you aren't going to make any money. Likewise, if your promotion mix includes "premium service," or "the best product in the industry," your pricing strategy has to be consistent with that as well, and you should be as expensive, or more expensive, than anyone else. Inconsistencies in either direction will lead to skepticism in the consumer--which is always bad for sales. The thing is, just about no one appreciates a "deal." Instead, most consumers are automatically suspicious: They'll try to find a reason for it.

Once you've figured out a ballpark range, the second method, used by a lot of managers, is break-even analysis. How many of these crystallization contracts am I going to be able to sell at $400? How many at $500? $600? $50,000? And what's my total cost for filling these contracts? If it costs you $200 in supplies and time to crystallize a protein, and your fixed costs, or the costs of rent, overhead, and management, is $20,000 a year, you have to crystallize 100 proteins per year in order to break even with a price of $400. If your price is $500, you only have to crystallize 67 proteins to break even. What are the chances that reducing your price by $100 is going to get you a 50% increase in sales? And, if increasing your price to $600 is going to make you lose 20 clients, you're better off charging $500 (your break even at $600 is 50 contracts). The crazy thing is, it might actually be better to crystallize one protein, for a really stupid client, at $50,000, than to do two dozen or so at $400 a pop. So break even analysis helps you figure out which price is most profitable, not which price leads to the most sales.

Doing "sensitivities" on price in this way (trying to figure out how sensitive your sales volume is when the price changes) is an art. Millions of dollars are spent on it, hundreds of thousands of surveys are handed out, and thousands of people make their living doing just that. But, at its most basic, it's really common sense. If your competition is charging $500, and your main selling feature is that you're cheaper, you're going to lose a lot of sales if you're more expensive than them. And you're going to steal quite a few sales if you're a lot cheaper than them. Unless, of course, you're too cheap, then people will think your quality is suspect.

The third and most accurate way of figuring out the price for your item is determining its "value." If you can figure out exactly what the product is worth to your client, that's what you should charge. So, choosing your price comes down to the same lesson as picking any other part of your marketing strategy: Know your client.