The problems with Pricing

By Mainak Biswas April 19, 2007 - 770 views

Any of us who have ever placed a formal bid for a project must have come across absurd prices from competitors that defy common sense. After observing this for a while, it is typical that the organization leaves its own pricing principles and attempt to cut-down or increase its prices.

So how should organizations price themselves? Economics tells us that prices are determined by the dynamic equilibrium of Demand and Supply so that at the equilibrium price the demand and the supply are equal to each other.  In simple English it means, if all you are not pricing high then all your employees should be working on paying projects and it you are pricing too high then you will not have paying projects. On the other hand, if you are unable to keep with the number of projects and the HR department has to work overtime then may be its time to increase your prices.

But, the big fat books on Marketing tell us that pricing should be done based on the perceived value of goods or service and not on its actual value. Thus, even if it costs $250 to make an iPod, it can be sold at $600 and this is how business consultants can demand for such insane prices and we pay them gladly!

The sad truth is that most of the time organizations don’t know how to price themselves. Too often prices are determined by the internal cost structures on the company or prevalent market prices rather than “value” or “demand-supply”. The most common logic is – “we will 4 months on the project and with 2 persons working on, it will cost us X amount of dollars so let’s quote 1.5X for the project” or, “every body is selling it at $400 – $500, lets price it within this range only”

For an average organization that is locked in a bidding scenario, it the option to either under-price or over-price.

Under-pricing is used either as an “account penetration” or “staying in business” strategy. Many times, companies under-price because they just don’t know what to quote. An organization whose sales people are busy placing 50 odd bids on places like Elance etc , really don’t have the time (or may be even the knowledge) to correctly evaluate each project. This is also true for organizations that has under-staffed its sales department. They bid low in order to get the job and within few weeks (or even days) or execution, they realize that the job cannot be completed within the price and they will have to accept losses on the project. In this case the organization simply decides to accept the loss and learn the lesson or it decides to throw in the towel. In former case, this still means that corners are cut, scope is reduced, quality is ignored and the customer suffers. This is because an under-bidding organization is more focused in minimizing its losses than satisfying its customers.

Over-Pricing is the other side of the same coin. If a project is over-priced then there are only two possible outcomes i.e. either the organization will win the business or it will not win the business. If it is not winning the business then it will either adjust its prices or it will go out of business. However, winning an overpriced project poses its own set of problems.  How will the organization allocate budget for an overpriced project? If it expects Y% profit then allocation of (100-Y)% as the project’s budget will lead to excessive project budget which will give an false impression regarding the project’s team performance. On the other hand, if it decides to allocate the normal budget as project’s budget (given it knows what the normal budget is!) then it will lead to abnormal or excessive profits which will sooner or later drive more competition into business and create a pricing pressure.

Thus, in order to sustain the business and maintain the “elegance”, a lot more thought needs to be given on pricing. It is very important to first determine and then monitor the parameters based on which you are deciding how to price yourself better. Please note that “Better” does not means “Higher”!

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