Adopting a pricing strategy is an effective form of marketing that can dictate how well your business is received by consumers. However, it can also be a very tricky process that requires extensive research, strategic thinking, and collaboration with stakeholders. It is important to have an understanding of the avenues you could take to make an informed decision. As such, this article explains how a target pricing strategy could be an effective method of improving the profitability of your business.
What is target pricing?
Target pricing is a pricing strategy used by businesses to achieve profitability in a competitive market. It is different from cost-plus pricing where businesses determine the cost of manufacture, and then add a mark-up price to generate profit. Target pricing takes an approach that is pretty much the opposite of this. The basic steps are as follows:
Work out a target selling price
Determine how much you should be selling your product or service by looking at market conditions. How much are customers actually willing to pay? It is also useful to perform a competitive analysis to gain an understanding of what your competitors are offering. Whichever target price you land on, we suggest ensuring you abide by the pricing rules which you can read all about here.
Determine the desired profit
The next step is to figure out the per cent profit you want to make from each sale. This seems pretty straightforward, but make sure to arrive at a realistic figure which balances well with the selling price.
Calculate the target cost of your good or service
Simply subtract the profit mark-up from the target selling price to get your target cost. This will mean that your cost must stay below the target figure in order to generate your desired profit.
Running the numbers
Still unsure? Here is a hypothetical example to help.
You run a furniture manufacturing business. Based on the current market for coffee tables, you fix the selling price of your coffee table at $200. Your desired markup is 25% on the selling price which means that for every coffee table you sell, you will be making a $50 profit. You will therefore have to make sure that the cost of making your product does not exceed $150 ($50 profit subtracted from $200 selling price = $150).
Advantages
Target pricing not only ensures profitability targets are reached, but also offers a very customer-oriented approach to pricing. It takes into account the price expectation of the customer (and hence the cost price). The quality of the product or service will therefore meet consumer expectations and needs. Target pricing also encourages businesses to find innovative ways to simplify the design and manufacturing process. This achieves optimum output at a low cost. With this method, customers could be getting the best value for money!
Disadvantages
If you do decide to take a target pricing approach, there are some things you need to be wary of. An obvious issue with this method is that its success depends on how accurately a business estimates the target price. This can certainly be challenging. The price could be underestimated which could lead to a target cost that is too low. If this occurs, it could virtually impossible to produce a product or service of quality and value. If a company’s focus is to reduce costs, they could run the risk of cutting corners and adopting poor technology. This could be damaging to both the product and the reputation of the business.
Final remarks
Target pricing is useful if your business operates within a highly competitive market. Businesses typically use this pricing strategy if they are in an industry where demand changes according to price. So, if your business must rely on competitive pricing in order to succeed, target pricing would be a good strategy for you. But remember: adopting this method will require meticulous planning and coordination with your manufacturing team or suppliers to make sure the risks we highlighted above are minimised. If you want further advice on pricing, it is worth speaking to a business lawyer.
