Pricing: Art or Science?

“Whoa!” I blurted out. “I'm not going to pay that much for a workout shirt.” With that, I put it back and took my business elsewhere.

Later, I laughed as I considered that if the shirt had been priced just 51 cents lower — at $39.99 — I probably would have bought it. Then I laughed even harder at the person who came up with that price. Who in the world prices an item at $40.50?

The answer is actually pretty simple: It's someone who paid $20.25 for the item, and doubled the price.

As in the above example, it sometimes seems like pricing — probably the most important element in the success or failure of products and companies — is treated either as a perfunctory matter or as voodoo.

It's neither, of course. In fact, pricing is more like an art. That's why I decided to call Rafi Mohammed, the author of The Art of Pricing from Crown Business Press. I wanted to know how his method might be applied to an industry that has to balance its pricing structure between mass merchandisers like Wal-Mart and the large number of independent gift retailers.

Rafi points out that there are typically two methods used in developing pricing; both seek a “one-size-fits-all” price. One way is to work up from your cost to the selling price. Start with what it will cost to actually make the product, add additional costs such as freight, duty, etc., then allow for good profit and whatever that adds up to is your selling price.

The other method is to arbitrarily choose a selling price that feels right and work backwards. Decide that a product should sell for $10, and try to make sure that your costs will allow that to happen.

In either case, sales or profits are going to be lost. In neither case is the final price actually connected to the reality of the marketplace and the levels of prices that different consumers are willing to pay.

Mohammed's method takes a far more nuanced approach to pricing. It chooses a third way that involves using multiple pricing strategies that eke out the maximum profit the market will bear by considering multiple price points for product variations.

When I asked Mohammed how a gift manufacturer might want to approach pricing, one of his suggestions was to consider “versioning.” Versioning is creating variations of product and pricing for different kinds of retailers.

In other words, don't attempt to sell all formats to all customers. Rather, look at your customer base as a portfolio of retailers. Each retailer carries a different version of the product that best fits its clientele, and thereby plays a unique role in reaching the consumer market and maximizing your profit.

For example, a Wal-Mart shopper is typically driven by finding products at the lowest price. Vendors can sell Wal-Mart a basic, stripped-down version of their product. Meanwhile, a Target shopper is looking for more quality, and is willing to pay more for an enhanced version of the product. Sell Target a better version, but not your best.

Continuing with this logic, specialty stores attract a shopper who seeks best quality, uniqueness or even luxury. Vendors should offer specialty retailers a best-quality version with all of the bells and whistles. In this way, profit is maximized at every level. It's also good for the retailers at the different levels, because they're really not competing with each other — they're each just taking care of their niche.

An aspect of The Art of Pricing that I find particularly beneficial is the tool called “The Value Decoder.” (You can find it for free by visiting www.pricingforprofit.com/pricing-tool/.) This system asks you to find a competitive item that is as close as possible to being a substitute for your product. Then, by following a series of steps whereby you add and subtract value based on variables like quality, brand identity, market environment, etc., you can arrive at the right price for your product. When used in conjunction with the working up from cost method, it's an excellent way to calculate a price, maximizing both profit and sales.

Mohammed also points out that it's extremely important to get all aspects of the company involved in using the “Value Decoder.” It is, he says, particularly important to involve salespeople, because they understand their customers better than anyone else in the organization. The “Value Decoder” process educates and empowers salespeople by treating them as the experts they are, thereby making them powerful advocates.

Most importantly, this puts the salesperson in a position to turn what is typically a one-sided conversation with major retail buyers into a dialogue. Salespeople who don't know how to value their own product are in a weak position to deal with powerful buyers, who in reality know only marginally more than they do. By increasing their knowledge and self-respect, salespeople can truly take a seat at the table.

I was on my way to the gym the other day when I remembered that I needed a new workout shirt. I ran into a store, grabbed one and took it to the register. As I pulled out my credit card, I suddenly noticed the price: $40.50.