Note: This article was written for a jewelry industry publication in 2006. Though the examples are jeweler specific, the principles apply to all forms of small business. The pricing theory is as relevant to day as it was then.
There is no area of marketing more distressing to small business owners than that of pricing. Particularly in these times of fluctuating precious metal prices, jewelers are desperate for good advice on how to get the most out of their jewelry without creating customer backlash. Why all the stress? Because pricing – unlike other areas of the marketing disciplines – is more art than science. Ask twenty business experts about their approach to pricing and you’ll get twenty different answers – after you hear them groan about how they are sure someone has a better approach but this is the best they’ve been able to come up with. While it would be gratifying to offer a pricing formula that could promise to solve all your pricing anxiety forever, unfortunately there is no such panacea.
The good news is that there are some specific things to consider when establishing pricing. If you consider each of these areas carefully you are more likely to make good pricing decisions, and as you improve your pricing skills over time, you will make more good decisions than bad decisions. This is the way to win the pricing game; through consistent attention to the impact pricing has on your sales volume, and tweaking those prices to get to the market response you want.
Before you can determine your pricing, you need to determine your business objectives. The first thing to consider is your brand and related product positioning. If you are positioning your business as top-of-the-line-highest-quality-hand-crafted jewelry, your prices must be high enough to support this claim. Customers who are interested in “only the best” expect to pay a higher price. In fact, that is part of the appeal to them. However, if your brand positions you as an affordable alternative to pricey jewelry designers, then your price must be lower than those you are comparing yourself to. There are thousands of potential brand strategies – too many to go into in this article! The point here is that you must know your brand strategy and then carefully consider what your pricing message must be, because pricing definitely sends a message. Carefully consider what pricing is saying to your customers about your overall business as well as the item under consideration.
Now consider your market objectives. Is your objective to gain market share, or is your objective to achieve profitability? You might say both, but it’s difficult to achieve both simultaneously.
If you are trying to achieve market share, narrower margins will likely be part of your strategy. I would never recommend going after market share on pricing alone. A successful market share strategy must include clear differentiation and competitive advantage beyond low prices. But differentiation and competitive advantage along with strategic low prices on critical items can be a very effective way to take business away from your competitors.
On the other hand, if you are pursuing a profitability marketing objective and not worried about gaining in your market share, figuring out what your current customers want and delivering on that better than anybody else can be strategically combined with higher prices for a more profitable business. The icing on this cake is that you can gain market share through gaining your existing customers’ pocket share, but it’s still a profitability strategy rather than a market-share strategy.
The next thing to consider is your product lifecycle. Product Lifecycle Management (PLM) is a discipline followed carefully by the electronics, pharmaceutical, oil & gas, and auto industries. It’s a discipline that focuses management attention on the four phases of a product’s life;
While it may be tempting to think PLM thinking is applicable only to larger industries or industries with different types of products, every industry could learn something from PLM thinking.
Pricing in the introduction phase is typically at the high end (unless a company is introducing a new product specifically for the purpose of grabbing market share).Pricing in the growth phase remains high as “first-responder” customers make purchases. Customers who want to buy the newest thing are rarely price sensitive. Pricing is adjusted down in the maturity phase, as the product has paid for its own development and profit and the mainstream of more price-sensitive customers become the target. Price-cutting takes place in the decline phase as the market is harvested for the last hold-outs for price.
The product lifecycle thought process will provide more guidance for some jewelers than others. A manufacturer of jewelry will find it more immediately accessible than a hand-crafter of one-of-a-kind jewelry. But everyone will benefit from understanding it, and challenging themselves to utilize the thinking in their own business planning.
Every business has competitors, and some competitors are more obvious than others. If you own a jewelry store on a street with many other jewelry stores, then it may be clear who some of your competitors are. But if you have a store that features very high end jewelry designers and artists and the other stores are traditional jewelry stores, it’s possible you aren’t competing with them at all. Your competitor in that case may be a nearby art gallery. To gain competitive awareness consider not only who sells similar items to you, but where your targeted customers go to spend their money. Your customer may consider your business to be part of their jewelry budget. Or they may consider you to be part of their apparel budget, or their art budget, or their gift budget. Once you understand where your customers shop and which budget they consider your business to be a part of, you can consider your pricing strategy in a whole new light.
One thing businesses are frequently tempted to do in a situation of high competition is to lower their prices. This is extremely counter productive, because in the end, nobody makes money. Instead, use your knowledge of your customer to create value for them that your competitors are not creating.
- Do they value personalized service and relationships? Then deliver that and keep your prices higher.
- Do they value unique designs? Then deliver that and keep your prices higher.
- Figure out what you can give your customers that your competitors can not or will not deliver, and you can justify a higher price in a highly competitive market.
Sales and Distribution Strategy
How do you sell your products? Do you sell them directly to your customers, or do you sell them to stores? If you sell direct, do you sell through a storefront, or the internet, or ads in the local paper, or trade shows, or trunk shows? If you sell them to stores, do you make those sales personally, or through representatives? Most likely you use a combination of these approaches. There are two primary things to keep in mind as you consider your pricing in relation to your sales and distribution methods;
1) whether your ultimate sales price leaves enough room to give discounts to your selling partners and still provide you with profit over your costs,
2) whether your pricing strategy to your selling partners is designed to get you what you need from them.
Most companies pay attention to the first consideration, but give the second consideration short shrift
Of course, the most important thing you need from your selling partners is sales. But not all selling partners are the same. Pursue a pricing strategy that motivates the behaviors you know are necessary to move your product. Every designing jeweler knows the risks of selling on consignment to a retailer. With no risk associated with the inventory, the retailer may feel little or no motivation to put the product on display, actively promote it, or reorder it. If you sell on consignment, make sure you are in a position to promote and monitor the sales activity of your products. Make sure that the discount you give the retailer is smaller than if they were paying you for inventory or taking on some of the responsibility for promotion. In this way you provide an incentive to the retailer to take a more participative role in the sales of your product. While you may have to sell on consignment on occasion, it is in your best interest to use wholesale pricing to motivate greater sharing of risks. All of the following terms relate to wholesale pricing, which should not be confused with list pricing.
- Trade Discount: Discount from list price.Based on services made available by the retailer or distributor, including holding inventory, buying bulk quantities, redistribution etc.
- Quantity Discount: Additional discount off of Trade Discount for ordering in large lots.
- Promotional Discount: Additional Discount off of Trade Discount for selling partners who share in the promotion of the products involved, primarily through advertising, fliers, circulars, or in-store promotions.
- Cash Discount: Additional Discount off of Trade Discount to encourage prompt payments of accounts, typically a small discount such as 2%/N-30 or 3%/N-15.
Make sure that your pricing is predicated on getting something from your selling partner. When your selling partners negotiate hard for better prices, these discounts are the leverage you have to negotiate back. If you don’t, you’re giving away money and getting little or nothing in return.
I have saved cost considerations for last, for two reasons. First, cost considerations are very important, because they are the key to understanding if you have set your price high enough to make a profit. Second, cost considerations tend to be the only basis on which most small businesses set their prices, and that is very risky. So I wanted to explore all the other considerations before we got to cost.
A multitude of cost methods for pricing exist, though the most common are methods that take into account the cost of the items produced and then add on either a variable or fixed mark-up to set the price. None of these methods takes into account the variables mentioned above and as a result they are inelastic. This isn’t all bad. If you are unwilling to put in the extra work to consider all the variables discussed so far, then using one of these cost-plus methods will protect you from the most common pricing error – under pricing. Small businesses – and particularly small businesses that sell a product with a subjective price value – tend to under price their products for fear that they won’t sell if they don’t mark the price low enough. Using a cost-plus method ensures that you at least know your costs and are planning a mark-up above them. But the cost-plus method doesn’t permit you to intentionally under price to achieve a specific business objective, such as a market-share grab. Nor does a cost-plus method allow you to see when your prices should actually be higher.
The most important consideration of cost in the pricing model is that you know your costs. You must know your material costs, your scrap and waste costs, and the cost of your labor. It’s easy to underestimate the cost of labor. Make sure you don’t limit your assessment of your hourly value to the hourly cost you are paid (or are paying yourself). If you are operating a large business with many employees, that figure is usually somewhat realistic, but if you are an owner-operator that figure is persistently undervalued. For owner-operators, consider the following:
First, consider the revenue you would like to generate for the year. For example: If you are a custom jeweler making one-of-a-kind pieces, you can make an average of 2 pieces per week, and you wish to have revenue of $200,000 in a year, your average item would have to sell for $1,900.00. If you are a small production jeweler selling to retailers, you can make approximately 500 items per week, and you want revenues of $500,000/year, then your average wholesale price per item would have to be $19.25, and the average product retail would have to be between $48.00 and $58.00.
For each example – or better yet, for your own example – once you deduct the price of metals and supplies for each piece, do you have enough space between the cost of the item and the projected selling price of the item to properly account for your time? If not, either your revenue expectations or your selling price expectations need to be recalculated. These examples are not intended to create a formula for pricing.Rather, they are intended to challenge you to test your assumptions and see if they are realistic.
Metal Costs and Pricing
In 2005 and 2006 we saw the first volatile metals markets in over 20 years. This presented a great challenge to retailers and designing jewelers who had not had to deal with the impact of volatility before memory. And even though metal price volatility has continued to the present day, it remains true that one of the greatest risks a jeweler faces is that she will not be selling her products at a high enough price to ensure she can replace the metals she has just sold.
I don’t recommend that small businesses dealing in precious metals play the market. Market futures are best left to people with lots of money to lose. The most prudent thing a small metals business can do is buy metals as they need them – no less, no more – and sell their products as close to market prices as possible. If you adjust your pricing to take into account the metal prices on the day you sell them, and buy replacement metals at the same market, you will guarantee that the margins at which you are selling are sufficient to give you the cash flow you need to replace the metals. During times of significant metal price volatility you will still have periods of unusually high margins followed by unusually low margins, but buying and selling as close to market as possible is the best protection for cash flow, which is the most important thing to protect.
We started this discussion by acknowledging that pricing is more art than science. But by taking into account factors such as brand, product positioning, market objectives, product lifecycle, competitive awareness, sales and distribution strategy, and costs, you can create pricing strategies that serve your long term business objectives of making money and having capital to reinvest in your business.
(c) 2006. Andrea M. Hill