How to Judge the Results of a Price Test

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So you are running a price test? But how do you determine which price wins?

It may seem like a dumb question, but it’s not. Sometimes the obvious answer is not the right one.

First, let’s establish the goal of the price test. In most cases, your goal will be to sell more of Product X. But you don’t care about just the raw volume of products sold. You care about revenue. And you care about profitability.

However, some companies use products as loss leaders, offering low prices to get customers in the door in hopes that they spend more money down the line. In that case, you might look at raw customers or sales to judge a winner.

And when launching a new product, your goal might be to drive as much revenue as possible, without caring as much about profitability. That would also change the metrics you use to judge the results of your price test.

But assuming your goal is profitability, you are going to measuring total contribution. To do that, you will need to know your variable cost per unit sold (marketing cost + cost of goods). Your contribution margin is the difference between the revenue and the variable cost.

If you sell 20 X’s at $20 per, and the variable cost per unit is $5, then you made $300 in total contribution (20 – 5 = 15 x 20 = 300).

And if you sell 25 X’s at $18 per, with a variable cost still at $5, then you made $325 in total contribution (18 – 5 = 13 x 25 = 325).

So in that case, $18 is a better price.

Top Pricing Blog Posts

We always say it – pricing is one of the most under-appreciated, under-utilized tools in the marketer’s tool belt. If only every marketing manager and small business owner knew the power of pricing, they’d be so much better positioned to succeed.

Luckily, we have a few blog posts on the subject that can help. Today, we wanted to present our most-read blog posts on pricing from the past few years. Here they are:

  1. The 1% Theory of Pricing
  2. 3 Ways to Set Your Price (and Which Works Best)
  3. How to Successfully Charge a Higher Price
  4. Will You Match Your Competitor’s Price?
  5. What Your Price Says About Your Brand
  6. How to Make Variable Pricing Work for Your Business
  7. Low Price Wins
  8. Price Testing Explained
  9. Will You Honor an Expired Coupon?
  10. Do You Compete on Price?

3 Ways to Set Your Price (and Which Works Best)

There are three common ways to price a product or service.

  1. Cost Plus Pricing
  2. Competitor Minus Pricing
  3. Value Based Pricing

Cost Plus Pricing

Cost plus pricing is so named for the equation used to arrive at a final price. The person setting the price calculates how much it costs to create and sell the product, then sets the price above that number to afford an acceptable margin. For example, if it costs $10 to produce each good, and $5 in marketing costs to sell it, and you need a 10% margin to be profitable, then you will set your price at (10 + 5) x 1.1 = $16.50.

Competitor Minus Pricing

Competitor minus pricing gets its name the same way. In this model, all we care about is what the nearest competitor’s price is. We want to match it or beat it, so that we can use price as a way to attract new customers. If they are selling their product for $16.50, we want to sell ours for $15.99.

Value Based Pricing

Setting a price using value based pricing is more difficult than the two models above. But the principle is simple. Price your product based on the amount of value it provides the end user. Take into account the consumer’s alternatives, and their cost. Then figure out how your product is better or worse than those alternatives. For example, if a competitor offers a similar product for $15.99, but our product lasts twice as long as theirs, an appropriate price might be something closer to $29.99.

Which Works Best?

Pricing is not a one-size-fits-all decision. And no model is perfect. But of the three basic practices detailed above, value based pricing is best.

Why? Cost plus pricing and competitor minus pricing both have inherent flaws that value based pricing does not.

Cost plus pricing does not take into account the consumer’s alternatives. You are pricing based on your costs. But what if a competitor’s costs are lower. They will always be able to underprice you. In addition, cost plus pricing does nothing to maximize profitability. Perhaps you could sell it for more, but your formula prevents keeps you locked into a lower price.

Competitor minus pricing forces you into a low-price mentality that can be very difficult to succeed at. It forces you to cut corners and save money in ways that new entrants in a field can’t always do effectively. It keeps you from creating more value for your customers because price is what defines your offering.

When you use value based pricing you can take all factors into account and set a price that makes the most sense based on your specific offering, and the market you hope to win.

How to Make Variable Pricing Work for Your Business

Pricing is one of the most under-discussed, under-utilized tool in marketing. Though it is one of the Four Ps we all learn about in Marketing 101, we too often take for granted that the price is the price and there’s nothing we can do about it.

But price is a lever we can use to improve returns in a multitude of ways. One popular strategy is the introduction of variable pricing to your product line.

Variable pricing, in the broadest sense, means offering different prices for the same products at different times, locations, or to different audiences. There are many different ways to do it, as the large number of companies that execute these strategies successfully have proven.

Below are a number of the most common forms of variable pricing, which you can apply to your business in order to get more mileage out of your existing marketing efforts:

  1. Amazon famously got caught showing different prices to different users for the exact same products. Amazon, and other technology-intensive companies, are in a constant state of price testing. By showing different prices for the same products over millions of different site interactions, they can use variable pricing to find the price point that provides the maximum profit for each product.
     
  2. Uber is widely derided for their “surge pricing” model, which follows the basic law of supply and demand. When more people are using the service, prices go up. You can use a similar strategy to increase profits during times of increased demand.
     
  3. Ebay made the auction pricing system popular, where customers compete on price so that sellers are able to maximize their earnings for each product. Auctions work when supply is limited by gaming demand.
     
  4. Time based pricing is common with hotels and airlines. Similar to Uber’s surge pricing model, their prices go up and down during specific times of year, days of the week, or time of day based on the likelihood that people will be travelling.
     
  5. Many physical retailers will use variable pricing based on location. They might offer a product for one price in New York City and a different price in suburban Pennsylvania.
     
  6. Discounting is a form of variable pricing many companies use. Offering discounts at specific times or to specific categories of customers helps drive sales where they otherwise might be low or non-existent.
     
  7. Pricing based on benefits allows companies to suit a product to each individual customer’s needs. Car dealers and many B2B sales use negotiation to match a variable set of “options” to the needs of the customer, where the pricing will depend on the final product.

As with any pricing strategy, your goal is to maximize profits. Use variable pricing if it allows you to find a more effective balance of sales and profit margin per sale.

Ethical Questions for Marketers – Part 5

Welcome to the newest installment of our weekly blog series, Ethical Questions for Marketers. Each week we plan to introduce a new topic and explore it in detail, preparing marketers for the day when they face such a problem at their organization.

Last week’s topic was Competitor Spying.

This week’s topic: Price Consistency

Pricing is an important topic for marketers to learn more about, made even more important due to the fact that is commonly overlooked as a lever we have at our disposal. But pricing decisions do not come without ethical considerations.

Under the subject of pricing consistency, one can run into several ethical problems. Many of us think that if we offer a product, that product has a price. It’s simple. That product costs X.

But that’s not always how it works. Many companies practice some degree of variable pricing.

There are legal issues in variable pricing. For example, it was quite common in the past for companies to charge black people more than whites. That’s illegal. And before the Affordable Care Act outlawed this practice, it was common for health insurers to charge sick people more than healthy people.

Then there are variable pricing strategies which are still perfectly legal. Amazon made headlines early in their rise to dominance in the ecommerce space when it was discovered that the pricing users see on their website doesn’t always match what other users see. That’s because Amazon uses pricing algorithms to determine what price they can charge you as an individual in order to get you to purchase a product. The goal is to charge as much as possible, so that they can maximize their profit.

Many B2B companies and auto dealerships offer customized pricing models, where the price someone pays depends on features and negotiating skills. And B2C companies regularly uses special offers and discounts that are available to only a select audience (for example, email subscribers or loyalty program members).

So where do we draw the line? As long as what you’re doing is legal, it is up to each company to set their own rules around pricing consistency.

To help you, determine how you would explain your pricing strategy to a customer who feels ripped off. If you can’t do it in a way that would make sense to them, you’re probably outside of your ethical comfort zone.

Stay tuned next week for another installment of our Ethical Questions for Marketers series. If you have an ethical topic you’d like to see addressed, write us.