Getting the pricing right is harder than it seems

6Icr9fARMmTjTHqTzK8z_DSC_0123

On the surface, getting your pricing right should be easy. You look at the value your product provides users and understand the amount they are willing to pay through price-sensitivity testing. Then, keeping your competition in mind, you set your pricing so you maximize the overall revenue.

(At this point, I’ve assumed you want to be profitable and that the price you charge is going to be higher than your costs. This may not be the case, of course, if you are a startup focused on user acquisition with loads of VC backing. If you’re selling your stuff at a loss for no apparent reason, however, you’ve got bigger problems than you realize and should stop reading right now. You should probably stop selling right now, too.)

So far, so good—and everything is fairly straightforward. But this simple process works only if you are selling a product or service directly to one market, in one currency and in one region. The fun begins when you add layers of complexity such as when you have multiple products, each being available in different countries and, therefore, in multiple currencies. Or, when you have all that plus a multi-tier distribution channel for a product that has been on the market for many years. This is where you really earn your stripes.

To make things a little easier, let’s look at the various elements. First, exchange rates. The easy solution here would be to put in place a dynamic-pricing model based on a daily foreign-exchange rate. Even if you are selling direct to your buyer, this is still a sub-optimal solution.

Why? Because of something called psychological pricing. We all know a price of $49.95 will move a product out the door faster than a price of $51.12. If you adjust your daily pricing based on exchange rates alone, you don’t have control over this aspect of pricing—your US dollar might get you 122.755 Japanese ¥ one day and 119.785 the next. (As far as I know, psychological pricing is valid not only in the USA, but world-wide, at least to some extent.)

Let’s assume you are going to set the exchange rate and, in doing so, you add a buffer to cover reasonable currency fluctuations. When contemplating the psychological pricing in the local currency, you must also consider whether local merchants display pricing with or without taxes.

Across Europe for example, the price shown should include regional value-added taxes (VAT), usually around 20 percent, although this varies by country. In the US and Canada, however, the taxes vary by state or province and, customarily, prices are shown without taxes, letting the customer enjoy the surprise at the end of the transaction.

Maybe it’s because I am originally from Europe, but I would argue that displaying the full price, including the government’s take, makes for a much better user experience.

One more thing on exchange rates. As has been shown in recent months, it’s best to think through, in advance, how to adjust local pricing when foreign-exchange rates expand beyond your buffer (and, sometimes, stay there).

If you sell a subscription, customers in Germany might not be happy to learn that their pricing is going up because the euro is going down compared with the US dollar.

If you sell physical products or perpetual licenses, the best time for a local price change is usually when a new version comes out. But even then, remember the psychological pricing comment above. I’ve experienced first hand moving from CA$499 to CA$549 because the Canadian dollar had taken a beating. And crossing the $500 threshold had a visible impact. From a user perspective, your expectation is for a quick price drop when the exchange rate is positive and a steady price when the rate goes the other way, don’t you?

Now, let’s look at selling through a multi-tier distribution channel. In most cases, the creator of the product will work with only a handful of distributors. The resellers, retail stores and e-commerce sites will get their goods from these distributors and not from the vendors directly. In some cases, you can even have an extra distributor in the middle.

Everyone involved will expect a certain margin that will allow them to cover their costs and make a profit. Therefore, you have to consider another price option in addition to the one the end-user will actually pay. To simplify the explanation, this is often called the “disti” price, that is, the price the vendor charges its distribution partners. This disti price will be discounted from the one the end-user pays. Easy, isn’t it?

Oh, and different channels will require different levels of margins—it’s a lot cheaper to operate an e-commerce site than it is to operate a bricks-and-mortar store.

But because you can’t really set your disti pricing based on who the distributor sells to, what margin do you use for the disti price calculation? If you set it too low, you will be uninteresting to many resellers and retailers. On the other hand, if you set it too high, your product will get heavily discounted online. It’s illegal to force an end-user price in most countries. Often, the best you can do is set what is known as the Manufacturer’s Suggested Retail Price (MSRP).

When you start mixing up country-specific pricing requirements with the channel margin required to sell in a specific region, that’s when the fun really begins. The size and complexity of the market, plus the competition amongst resellers within a country, often has an impact on the margin required.

For example, the spread between the disti price and the MSRP in the USA should logically be lower than the one in Italy or France. (Think of European Union members as individual and often disparate countries, not one union of states as in the USA. At least this is the case in the high-technology world.)

In addition, the shipping costs for physical goods can be significant factors in certain regions depending on where you are manufacturing your products. And emerging markets offer a whole new level of challenges not least of which are piracy and counterfeit goods, the complexity of the distribution network, shipping costs (for physical products) and specific customs costs and other import taxes. In those emerging markets, you should also consider that the GDP per capita is a lot lower than in western countries, so should you may have to consider a much lower price point. In this case, keep in mind that due to piracy (especially in the software world), you are often competing with yourself at $0.

Other things to consider include the historical pricing in a market as well as how you structure volume discounts. Given that anyone around the world can check—in real time—the price of your product in the USA on amazon.com, it’s clear that there is no easy answer to the pricing question. When you craft your product with care, you need to think of the whole user experience. As always, success is in the details. But so, too, is the devil.

Original picture and photographer credits available at http://unsplash.com/.

Feedback, Comments, Additional Ideas?