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Art or Science?: A deeper look at pricing strategies

By Richard Gottlieb

 

I was on my way to the gym when I remembered that I needed a new workout shirt. I ran into a store, grabbed one off the counter and took it to the register. As I pulled out my credit card, I suddenly noticed the price--$40.50. "Whoa," I blurted out. "I'm not going to pay that much for a workout shirt." I put it back and took my business elsewhere.

Later, I laughed at myself as I considered that if the shirt had been priced 51 cents lower (at $39.99), I probably would have purchased it. Then I laughed even harder at the person who came up with that price, because who in the world prices something at $40.50? Well, the answer is simple: someone who pays $20.25 wholesale and then doubles the price.

As in this example, sometimes pricing--probably the most important element in the success or failure of products and the companies that set them--is treated either as a perfunctory science or as voodoo. Maybe, however, it's neither. Maybe it's an art.

That's why I decided to give Rafi Mohammed, the author of the Crown Business Press book The Art of Pricing, a call. I wanted to know how his method might be applied to an industry that has to somehow balance its pricing between mass merchandisers like Wal-Mart (NYSE:WMT) and the large number of specialty retailers.

Mohammed says that, typically, there are two methods used in developing price. Both seek a one-size-fits-all solution. One method is to work up from your cost, and whatever that calculates out to be is the selling price. In other words, start with what it will cost you to actually make the product, add in additional costs such as freight and duty, allow for profit and whatever that adds up to is what you sell it for.

The other method is to arbitrarily choose a selling price that feels 'right' and work backwards. In other words, you decide that it should sell for, say, $10.00, and you try to make sure that your costs allow that to happen. In either case, sales or profits are going to be lost because the final price isn't actually connected to the reality of the marketplace or to the various levels of prices that different consumers are willing to pay.

Mohammed's method takes a far more nuanced approach to pricing. It involves pricing that ekes out the maximum profit the market will bear by considering multiple price points and product variations.

Pricing for the toy market

When I asked Mohammed how a toy manufacturer might want to approach pricing in this industry, one of his suggestions was to consider versioning. Versioning means that you create variations of your product and pricing for different kinds of retailers. In other words, you don't attempt to sell all formats to all customers. Rather, you look at your customer base as a portfolio of retailers. Each retailer carries a different version of the product that best fits its clientele, and thereby plays a unique role in pleasing the entire consumer market and maximizing your profit.

For example, a Wal-Mart shopper is typically driven by finding products at the lowest price, so sell Wal-Mart a basic, stripped-down version of your product. A Target shopper, however, is looking for more quality and is willing to pay more for an enhanced version of your product. So, sell Target a better--but not your best--version. Continuing with this logic, a specialty store may attract a shopper who seeks the best quality, uniqueness or even luxury. Sell the specialty retailer a best quality version of your product with all of the bells and whistles. In this way, you maximize your profit at every level, as do your retail customers, because they are really not competing with each other. They are each just taking care of their own particular niche.

The Value Decoder

An aspect of The Art of Pricing that I find to be particularly beneficial is the Value Decoder, which you can find at (www.pricingforprofit.com/pricing-tool) . This system asks you to find a competitive item that is as close as possible to being a substitute for your product. Then, by adding and subtracting value based upon variables like quality, brand identity and the market environment, you are able to develop the right price for your product. When used in conjunction with the working-up-from-cost method, it is an excellent way to calculate a price that maximizes profit and sales.

It is extremely important to get all aspects of the company involved in using this system, particularly salespeople, because it's salespeople who understand a company's customers better than anyone else. Tools like the Value Decoder can educate and empower the sales team by treating them as the experts they are. Most importantly, this puts the salesperson in the position to turn what is typically a one-sided conversation with retail buyers into a dialog. Salespeople who don't know how to value their own product are in a weak position to deal with buyers. By increasing their knowledge and confidence, salespeople can take a more powerful seat at the negotiating table.

Richard Gottlieb is president of Richard Gottlieb & Associates LLC, a provider of business development services. He has 35 years experience in the toy industry in sales and sales management. He can be reached at richard@usatoyexpert.com