When companies look at their product mix, should they use the same pricing strategy for all products or view their product mix as a product portfolio where pricing strategies should be managed differently? Well, some companies essentially use the same pricing strategy, regardless of any given product’s position in the market. However, other companies adopt a product portfolio management approach to their product mix in much the same way investors manage their own investment portfolio. In this sense, each product is measured on its own merits. Companies don’t use the same pricing strategy, nor do they expect the same gross profit returns. So, why would a company manage their products’ pricing strategy differently from one product to the next?
The Specialty Retail Store That Wasn’t Very Special
Before going into discussing how small and medium sized businesses should use a product portfolio management approach in their product mix, I think it would be ideal to provide an example of how one pricing strategy for all products can be problematic at best. My wife and I have a weekend ritual of going out for breakfast. Afterwards, we often stop to look around inside a hunting, fishing and camping retail store located just beside our favorite place. On one particular weekend, there was a sign on the outside of the store that read 50% off everything!
I knew this store well, not because I shopped there, but because I knew from the day it opened that it would be an abject failure. I am an avid fisherman and take the family camping yearly, so I have a fairly good idea of the reasonable price range for the store’s products. The premise was that it was a specialty store carrying products the typical Wal-mart, and other larger chains, simply didn’t carry.
While this was true, and perhaps warranted higher prices for those hard to find products, the rest of the store’s products – the ones that could be purchased at those other chains – were so obscenely priced, that it made absolutely no sense to even contemplate buying them.
Even with this huge sale, people weren’t buying the pitch. I took a quick look around the store and did a quick summary of this retail store’s product mix. I figured that at best, maybe half the product mix could be termed “special / hard to find”. The rest was “generic / me-too products” anyone could get anywhere else. Suffice it to say, the store closed a couple of weeks later. Now, some may say that this is merely the result of a bad economy. However, even in the best economy, customers won’t buy the same product for premium pricing if they can get the same product elsewhere, at a fraction of the cost.
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Why Did the Retail Store Fail?
Now, I am not a retail expert, nor have I ever worked in retail. I am sure there are a myriad of reasons why retail outlets like this fail. I know that competing against larger chains isn’t easy, but I also know that retailers run tight margins and this retailer’s idea of margins where exaggerated. I know this because I shop at another small specialty store that carries the exact same products. It’s just another independently owned retail store.
Regardless, I can say that if the prices on those generic products were more competitive, people would have purchased them. This store had it all and it could have easily been a one-stop shop for the avid outdoorsman. However, there just weren’t enough sales of their generic product lines. If my assumptions were right, and the store’s product mix makeup was 50/50 between those “special / hard to find products” and their “generic / me-too products”, then it’s easy to see that any profit made on the special products, were quickly eroded by the lack of sales on the generic ones.
What is The Product Portfolio Management Approach?
This experience led me to think about how small and medium sized businesses should use a product portfolio management approach within their product mix. In this case, there are products that pay the bills, and there are products that make up the majority of the company’s gross profit. The “generic / me-too products” pay the bills and the “special / hard to find products” bring in the money.
Now, this doesn’t mean a company doesn’t make any gross profit on those generic products. It just means you can’t use the same pricing strategy for all your company’s products and therefore shouldn’t expect the same returns. Going back to the reference about an investment portfolio, why do most investment professionals advocate holding a balanced portfolio of investments, one that has growth, stability and safety? It’s because those safe investments still provide some kind of return in even the worst of times.
Product portfolio management simply implies that a business use a different pricing strategy within its product mix, one that matches a given product’s strengths, or lack thereof, to a price that maximizes returns – even if they’re minimal. It therefore requires that your business know its market. Knowing your market means knowing what price your customer will purchase at, and knowing your competitor’s pricing for those “generic/me too products”. Deciding how to price your company’s products typically falls under the following pricing strategies.
Premium Pricing: Sometimes products can be differentiated by price alone. By this I mean that a product with a high price can often lead consumers to assume it must also be of high quality. It’s simply a matter of perception, and if perception is truly 100% reality, then sometimes companies can charge a higher price for the same products offered by their competition. In this sense, this would have meant that the retail store could have charged more for their “generic/me-too products”. However, premium pricing is hard to make work – especially when competition is high.
When can premium pricing work? Well, sometimes it works with niche markets where customers don’t have access to competition. In other instances, it can work with companies that must prepay because of bad credit. In other cases it works when the brand name of the product is so highly revered by customers, that they are willing to pay a higher price. This is often the result of strong product brand marketing where customers have a higher perceived value in the company’s product.
Market Penetration Pricing: When companies want to steal customers and increase market share, they often adopt market penetration pricing. This simply implies that the company charges lower pricing to secure higher volume or to steal business. Companies that tend to use this approach are newcomers to their market or industry, or small to medium sized companies that want to become market challengers. These companies will identify those “generic/me-too products” within their product mix, and charge lower prices to win business.
Fair Market Pricing: This pricing strategy is used to bring parity to those aforementioned “generic/me-too products”. This pricing strategy typically adopts a price range that is in line with market pricing from competitors. This requires an approach that is predicated on knowing your market. This means knowing your customers, as well as your competitors within your market, and relying upon market research to determine your product’s pricing.
Cost Plus Pricing vs. Gross Profit Margin: Cost plus is when a company takes its COGS (Cost of Goods Sold) and adds a set profit. In this case, a company may have a cost of product of $100.00 and therefore decides to make an even $15.00 profit on the sale – so, they charge $115.00. Cost plus isn’t the most popular pricing strategy, but it does have a place with those product lines a company wants to sell regardless of the product’s lack of market strength.
Gross profit margin is less of a pricing strategy, and more of a statement of how much of the company’s sales are used to cover the company’s COGS. Gross profit margin factors in the company’s gross profit within the product’s price. The COGS are those variable & fixed costs of the sale. Included in COGS is often the labor, freight, duty, material costs etc. Gross profit margin is calculated as follows:
Using Loss-Leader Pricing Strategies: While rare, there are instances where a company can price finished goods to sell at a loss in order to increase market share. This often involves adopting loss-leader pricing strategies, ones predicated on incurring losses to increase business. This strategy was masterfully used by Sony in order to grab a large share of its market on its gaming consoles. The strategy was to sell these consoles at a loss in order to secure higher profit on sales of software, games and ancillary products.
The table below is an example of what a loss-leader strategy might look like. In this example, Sony has lost on consoles, but more than made up for these losses with large profit margins on software and games. To read more about this strategy, please see: Product Life-Cycle Management: Grow Market Share by Selling at a Loss
Product portfolio management simply means that a company adopts a varied approach to its pricing strategies within its product mix. Not all products can provide the same returns and not all products can benefit from the same pricing strategy. This is somewhat akin to the “Boston Consulting Group Growth Share Matrix” that has become such a staple of marketing professionals when they measure a product’s life, its price, its market share and its returns.
I’ve simply put a small spin on it by breaking it down into two product groups – the “generic/me- too products” and the “special/hard to find products”. While this may seem somewhat simple – try telling that to the owner of the specialty retail store that went out of business.
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