The Four Principles Of Pricing
September 17, 2015 
There are several fundamental principles for pricing. If you’re setting prices without being aware of these, chances are high that you’re making less money than you should.
Markup Is Not A Pricing Principle
Marking up is a common practice, but the wrong one for a specialty retailer like a farm market. It is really little more than a bad habit. I know that statement is leaving most of you confused. If you don’t mark up what do you do? Bear with me a few minutes, and I’ll explain. But first, write the word “markup” on a sheet of paper. Crumple up that sheet of paper and toss it in the round file over there in the corner. You’re done with it.
The Four Principles Of Pricing
Pricing does more than recover costs, but that is a good place for us to begin. You must at least do that even if you aspire to nothing more. Prices determine the ability of your business to stay in business and to generate a profit.
While the price must recover your business costs, it should be based on the customer’s perception of the product’s value.
1. Prices are first a function of recovering your four major costs of doing business. Each dollar of income breaks down into these areas:
a. Cost of investment (aka profit). $0.10 to $0.15 (EBIDTA)
b. Cost of labor (including benefits and owner’s compensation). $0.32
c. Cost of operating (including rent at fair market value). $0.17
d. Cost of goods (including freight). $0.41 (59 percent gross margin)
Now how are you going to get by with that little for your vendor friends? Don’t worry about that at the moment. We’ll get to it soon. You must know your costs first, or you cannot set your price with confidence that you will recover these costs.
Profit is rarely an accident these days, but losses almost always are.
Budgeting expenses is like putting on your seat belt. Things can and do go wrong. Well-run companies actually increase profits when something goes wrong and their sales go down.
2. Consumers determine value individually and decide how much money they will exchange for it. This is based on many factors including:
a. Urgency. When do I need it?
b. Inconvenience. How difficult is it for me to obtain?
c. Degree of need. How serious is my need?
d. Product awareness. Do I know the price?
e. Demographics. Can I afford it?
f. Psychographics. Why will I buy it?
3. Perceived value is the consumer’s assessment of everything you bring to the buying experience: quality, selection, surroundings, service, convenience and, not to be forgotten, the price. Too often we begin by setting the price when we should begin by creating value, then adjust the price to establish it.
Price perception is real. If the price isn’t equal or less than the value, the consumer won’t pay unless they’re in a corner. If they perceive the price is too high, and there is a degree of need and urgency, they will pay more once.
They may also share this perception with others, and you won’t be there to defend your value.
4. Product qualities. To deal with price perception we must consider the following in order of emotion to logic.
a. Desirability. Is the product appealing? How does it look here? How will it look when I own it? These questions are rarely verbalized, yet they are asked.
Fixtures, lighting and signage are pinpointed on this one specific area.
Vignettes that create a setting typical of where the product is used are helpful as long as they can be shopped from.
b. Durability. Will it last long enough to be considered an investment?
Quality of materials and construction are more critically assessed than we are used to. Stainless steel, granite, ABS plastics are examples of high-quality materials that are expected today.
Design is appreciated much more today. Customers will respond to thinking about how things look together, and the changes with the seasons. It’s still a mobile society, so they may not care as much as we’d like about how plants will look as they grow.
c. Availability. Can they buy something they perceive to be the same or better elsewhere without undue inconvenience?
Eliminate inconveniences on basic products that should be in stock.
Buying is becoming more of a science because we have to look beyond the easy buys to find more products that are highly desirable to the customer, but aren’t available to every other retailer.
e. Affordability. Can they truly afford the product or service? It’s no secret that many consumers now have unmanageable debt.
If we can show affordable choices by pointing out values such as durability, less total cost, lower maintenance, energy-saving, etc., it will have meaning.
d. Comparability. Comparisons are not always fair and can kill you if you’re commoditized. They can also make you a superhero if you’re differentiated. There are some ways to deal with value-comparable items when we must.
Reasonableness. If your price is 10 to 15 percent higher on an easily compared item, it may be acceptable to the customer in most cases. But it still reinforces that your prices are indeed higher.
Bundling. Sometimes a customer won’t compare per-unit prices when you don’t price the item in units. For example, potting soil the competition sells for $2.99 can be bundled at 3/$10.99, which seems reasonable. Yet the unit price is 10 percent higher. In addition, the consumer stocks-up and their current and future need for the product is sold. A variation is to bundle several different items together for one price.
Value-add. If you add value to the product with a service such as delivery, it will often overcome the price comparison because it brings value-related concerns other than price into play.
Competitive pricing. If you face severe competition you can competitively price a small number of comparable products to overcome the perception that your prices are higher than the competitor.
Pricing Techniques
Those principles lead us to the point of applying technique. It is helpful to know several techniques so you can better distinguish the difference between them and see which is most appropriate for you.
The three major pricing techniques are:
1. Mark-Up Based Pricing considers only the cost of the product itself. The price is often not enough, but is sometimes too much for the value offered. When the consumer considers the total package of product, selection, surroundings, service and convenience, some stores charge way too much. There are many retailers who offer me-too products, crappy surroundings, little service and are difficult to do business with. The answer to this problem is not to lower prices, but rather to increase the value, and the price will rise along with it.
2. Margin-Based Pricing recovers the four major costs of doing business and assures that minimum financial objectives are met. But it is still a mathematical equation that can undercharge the consumer for the value they receive. Margin-based pricing has a tendency to be well short of the profit potential from the investment in a retail business.
3. Perceived-Value Pricing recovers the four major costs of doing business, plus extra profit from the ability of your people to add value the consumer willingly and regularly seeks out. There are two approaches to selecting perceived-value pricing:
a. Set a value-added price based on the perceived value you create with product, selection, surroundings, service and convenience.
b. Verify that price meets your minimum financial objective. In other words, the margin-based price is your minimum. This is sometimes referred to as your “margin floor.”
You’re Supposed To Experiment
Pricing is a theory more than a specific practice. The value of an item is what the consumer is willing to pay. The marketplace will tell you what that is if you are watching, listening, measuring and evaluating, but you also have to experiment to find the magic number for you.
The consumer is the judge and jury of your pricing. It is more efficient, more effective and more profitable to focus on perceived-value based pricing, because that is how they will judge your product and your store.