This session completes the marketing plan. It describes the decisions you made, justified by your research, regarding the pricing policy you will have and the location, distribution choices you’ve made.
The pricing and location need to be consistent with your research and the buying behavior of your target market. The purpose of this session is to develop the pricing and location strategies which will complement the product and promotional strategies from the previous session.
Pricing is a critical variable because it can make the difference between success and failure. Some entrepreneurs feel intense pressure to make sales, and, if the competition is aggressive, you may reduce prices to a point where you are not profitable. On the other hand, if your prices are too high you won’t get sales and your business will suffer. Good research will give you an understanding of your customer’s expectations about price and the competitors’ pricing methods. This will be the starting point to establish your pricing policy.
Location and methods of distribution are decisions that will be based on your customer’s preference for receiving the product/service.
- Understand the relationship between quality and price
- Determine the appropriate pricing structure for your business
- Determine a suitable location based on weighted criteria
- Develop the distribution network ( if necessary )
- Summarize the marketing plan
Pricing is a very subjective concept. The value of any product/service is based on the perceived value that a customer is willing to pay for it. This will depend on:
(1) The availability of a substitute product/service
(2) The importance of this product/service to the customer at this time
(3) The perceived quality of the product/service
Perceptions will vary greatly. It is often up to the entrepreneur to set a price which will be accepted or rejected by the customers. When it is a new product and the customer is skeptical about the value, it is often wise to start with an “introductory pricing” model to have the customer try it. Once the value is established then subsequent sales can begin to move toward a “premium pricing” model.
There is often a perception by consumers that price reflects quality. If you price too low then the consumer will assume that your product/service is sub-standard.
An immigrant to Canada noticed that mountain bikes sold here in Wal-Mart for $199. were not very well made. In his home country he could get high quality bicycle parts cheaply. He decided to contact relatives and have them ship bicycle parts to him which he assembled into bicycles, in his basement.
Low overheads and low price parts enabled him to put his bicycles on the market for $129. These were much higher quality than the Wal-Mart bicycles but he wasn’t getting any sales.
Research was done which indicated that the consumers felt the low price was an indicator that the quality of the bicycle was poor. All he had to do was raise the price to $169 to have the consumers perceive the quality ( and the bargain in comparison to the Wal-Mart bike ).
Cost based pricing
This is similar to bottom up forecasting. You assess the cost that you incur in buying or making the product/service and then charge a mark-up for overhead and profit. An example would be a store that re-sells products purchased from a brand name manufacturer, The store buys a product for $1.00 and charges a 100% mark-up ( doubles up ) when selling the product. So, the store sells the product for $2.00, uses $1.00 to pay for the product and uses the other $1.00 to pay for overhead (salaries, rent, phone, etc.) and leave some profit.
In a perfect world this model works. It implies that you don’t have to be efficient or worry about any competition. Whatever you charge, the customer will pay. In reality, however, there is a fundamental problem – you cannot charge whatever you need to charge because a competitor will always be undercutting your price to make a sale.
It’s the fundamental law of supply and demand. If you are so unique that you have the only product or service in the market and you can charge whatever you want because the demand is so great, then others will be motivated to enter the market because of the high profit potential. As demand starts to become fulfilled, the suppliers (entrepreneurs) are now faced with competition. The power in the relationship shifts over to the buyers because there are now a lot of sellers to choose from and they will need to reduce price to get the business as customers shop for the best deal.
A real life example of this was the cigarette trade in Kahnawake when the tax increase on cigarettes drove the retail price, in Montreal, to $45 a carton. The first cigarette stores in Kahnawake could charge $40 a carton and do well because the customer was saving and there was nowhere else to go.
As the initial stores began to make significant profits, others were motivated to open cigarette stores because of the high profit potential. Now, all cigarette stores were selling the same commodity ( brand name cigarettes ) and there was no differentiation or uniqueness about the stores or the product. Buyers did not care about store ambiance, and all stores in Kahnawake were equally convenient. There was no value-added differentiation to make the product unique – all stores were just re-selling the product and the product ( e.g. carton of Player’s cigarettes ) was the same in all the stores.
So, customers were only interested in the cheapest price (shopping good). As more and more cigarette stores opened, the supply began to catch up with the demand and the power in the buyer-seller relationship switched from the supplier (cigarette stores) to the buyer of the product. The buyer now had choices about which store he/she wanted to purchase from. Since the product was the same in all stores, the buyer just went from store to store looking for the lowest price. So, if you were a seller and the buyer came into your store for a carton of Player’s and you said the price was $40, he/she would say they could get the carton for $38 at the store down the road. You now had to lower your price to $38 or you wouldn’t get any business. Then, another store would lower price to $36 in order to get more business. The lowest price seller would get almost all the business until every other store would match that. Then someone would go to $35 and so on until the sellers were making little or no profit on sales.
Now this occurs in a number of other situations. Three, in particular, are the gasoline industry, the liquor industry and the electronic products industry. In all cases the same situation exists:
a) The products are the same, name brand products and the re-seller is not adding any value. So, a Panasonic television is the same, a 40oz of Bacardi is the same and gasoline is pretty well all the same.
b) The re-sellers of the products do not have a convenience advantage because they are all close to each other and the customer would not be reluctant to switch to another re-seller for lower price.
So, why don’t these industries face the same fate as the cigarette industry in Kahnawake? The answer is collusion, either forced or agreed. Let’s look at some examples:
In the liquor industry, distribution and sales are controlled by the SAQ ( Societe Alcohols Quebec ). This government agency controls the right to sell liquor in the province of Quebec and can fix a price that all sellers must adhere to, or face losing their license to sell. That’s why a bottle of Bacardi is the same at all stores and any sale or promotion is the same at all stores. So, it doesn’t make sense to shop around because prices are the same.
In Kahnawake, the cigarette sellers would all have continued to make significant profits if the Band Council or Economic Development would have controlled the licensing of cigarette stores, requiring them all to sell for a set price of $35 per carton or risk losing their right to sell. Sounds good but for obvious reasons neither Band Council nor Economic Development could take a leadership position in that industry ( political and cultural constraints ).
In the Electronic industry, there are a number of stores close to each other on St. Laurent street in Montreal. They all sell the same name brands and they are close together. The government doesn’t regulate prices but the stores are all Pakistani owned and many are owned by the same owner ( a good business strategy is to create your own competition ). All stores willingly maintain prices and they will call the other stores to tell them a customer is coming since they know the consumers will shop around.
In Kahnawake, this would work if one person owned all the cigarette stores or if all cigarette stores agreed to collude together to maintain price. Neither scenario is realistic and the case in this section is an example of how the rivalry is often too great for synergy of opportunity.
In the gasoline industry, there is not one owner, there are 3 or 4 oil refineries. Also, the government imposes a tax but they do not regulate the selling price. Every gasoline station sells at the same price, however, and this collusion retains the price of gasoline at a controlled level. This is because of the association of gasoline refineries who do the regulation instead of the government or a dominant owner. There have occasionally been “gas wars”, usually started by independent gasoline re-sellers ( Supergas, Sergas, etc. ). These independents get their gas from a major refinery ( it’s too expensive to make your own gas ) and once they start to discount price the association steps in and warns them to stop or they will not get any more gas from any refinery. A couple of years ago there was a bombing at a Supergas in the West Island when they didn’t heed the message.
The presence of an association in Kahnawake may have regulated the cigarette trade if it had sufficient power to do so. The association, comprised of cigarette store owners, would set the standard price for the sale of a carton of cigarettes. Anyone attempting to undercut the association price would lose the right to sell cigarettes. The fundamental weakness here is that the association is not the manufacturer of the cigarettes. In the oil refinery instance, the association could control supply because they were the source of supply. In the Kahnawake scenario, the association does not make the cigarettes and regulating the sales and distribution would be perceived as too restrictive and too susceptible to kickbacks from the cigarette manufacturers.
So, there are a number of ways to regulate pricing in an industry to ensure that all suppliers can make a profit Government control (SAQ) and Associations of manufacturers ( gasoline ) are controlling methods and run against the independence and freedom of the community culture. Collusion on the basis of trust and common interest is best but this is difficult to achieve as the following case will attest to:
Competition erodes trust
In a non-aboriginal community there were a number of competing hairdressers who all purchased their hair care products from a supplier outside the community. Since each hairdresser purchased individually, they each paid full wholesale price for their products – and also “leaked” money outside the community.
A suggestion was made, by an economic development officer, for these individual hairdressers to form a “buying club” where they would purchase from the supplier as one group, giving them a better price because of volume discounts. They would then each purchase, individually, from their own buying club.
This creative opportunity was extended, as someone suggested that they use the buying club to purchase from the supplier in bulk and bottle the products, locally, themselves. This would allow them to purchase their supplies even cheaper. It would also benefit local economic development since local jobs would be created to bottle the bulk product and also there would be less leakage because the purchase price would be cheaper.
Building on that creativity, someone recommended that the local hairdressers should form a “manufacturing group” not a “buying club”. The external supplier did not have a “name brand” that was demanded by the hairdressers’ clients. Therefore, there was an opportunity for them to create their own brand and have it produced locally instead of buying it in bulk from an external supplier.
Notice the economic implications of this opportunity:
1) The hairdressers would now make their own shampoos, hair tonics, etc.,locally, in a facility that they would each purchase from individually.
2) No more “leakage” to an external supplier – except perhaps for raw materials at a much cheaper price.
3) A local business ( manufacturing shampoo, soap, etc.) that would create local jobs = workers with income to spend (hopefully locally).
4) The ability for each of them to purchase their supplies from their own manufacturing facility. Much cheaper for them, which enables them to charge less for their services making them very competitive with external community hairdressers.
5) Best of all, an opportunity to manufacture their own product that they could label and sell to external community hairdressers. Note that this would bring money into the community instead of sending it out.
What a great opportunity for hairdressers and community. Reduce community leakage because no more money is being sent to external suppliers. Create local jobs for the manufacturing facility. Each hairdresser can purchase from the facility at a very cheap cost. Finally, each hairdresser gets profit from the sale of the manufactured products to external communities and this profit is now inside the community (ideally re-invested in the manufacturing facility).
So, did this all come to pass? Some of you may have already guessed what could go wrong in this perfect opportunity. It wasn’t financing. The community was willing to invest in the manufacturing facility for community economic development. It wasn’t a problem with feasibility because the hairdressers were now purchasing a particular amount of product that would guarantee the success of the facility.
It was trust, or lack of it. They were all competitors and, even though they could see that this opportunity would benefit them individually, they did not trust each other enough to develop a manufacturing partnership together. Sadly, they still continue to purchase, individually, from an external supplier. Their costs are high and the money is leaked outside the community. They are also, individually, less able to compete with hairdressers outside the community and so there is more leakage as clients spend money outside the community.
An excellent opportunity wasted because of individualistic competition which created a lack of trust.
Demand based pricing
This is based on the top down approach that focuses on what the customer is willing to pay. This is more realistic when faced with high competition, particularly from the external markets of Chateauguay and LaSalle. There may be incentives of convenience and “buy Kahnawake” programs but the Kahnawake consumer is an economic person. Loyalty to community is without question ( e.g. 1990 crisis ) but, at the same time, the consumer needs to feed and cloth their family, drive their auto, purchase furniture, etc. They have an income that they want to get the most out of. So, if they can find better variety and price in Chateauguay then they are not reluctant to do so. Chateauguay businesses have an advantage, because of volume, so it is very difficult to compete on price alone for Kahnawake businesses. By differentiating, you can charge a premium if the customer perceives your product/service to be significantly better than the others. A small example will help:
A popular arthritis medication is rub A-535. This product is manufactured and then re-sold through pharmacies and other outlets ( Wal-Mart e.g. ). It is a branded product and the name, contents and size are the same in every re-seller’s outlet. So, price alone is the criteria for purchasing the product and naturally Wal-Mart would be in the best position ( economies of scale ) to sell for the cheapest price. A re-seller of this product, in Kahnawake would have difficulty, because residents would wait until they were going to a movie, in LaSalle, and buy the A-535 there, saving money.
So, the Kahnawake retailer would have to differentiate by finding a product that did not compete on a head-to-head basis. An example would be to find a holistic medication that was a home-based remedy for arthritis. Secret herbs would be blended to make an ointment which would be highly differentiated from A-535. Free samples, demonstrations, testimonials and other promotions would get consumers aware of the product. When a consumer became convinced that this product was superior to A-535 then they would be willing to pay a significant premium in order to obtain it. Now you have a business.
Pricing strategies are very important for profitability and market share. On the one hand you want market share ( a significant number of clients in relation to the total market ). On the other hand you want profitability which is a function of the price/cost relationship. You can have exceptional sales, without profit, and sell yourself into bankruptcy ( High market share, no profitability ). On the other hand, you can have a high selling price with few customers and end up in bankruptcy also ( High profitability, no market share ). You need to price according to the situation and the following is a guide to help in this regard:
You can charge a premium whenever you have differentiated yourself from the competition ( secret recipes, etc. ). You need to have the customer feel that your product/service is substantially better than the others and the customer is willing to pay more for it.
This is most evident with new “gadgets” that are invented and offered through infomercials on TV or at tradeshows. “Only available through this exclusive TV offer” means you’ll pay a lot because of the exclusivity. Whenever there is an opportunity for profits, however, there will be competition. Others will be motivated to “knock-off” the product/service and eventually the product will be sold on the basis of lowest price unless you can maintain your differentiation as the original, the best. This is seldom a “sustainable” market opportunity and you need to constantly look for new products as the old ones lose pricing potential when a version gets to the “pricing killers” of Wal-Mart and Price Costo.
A more sustainable, long-term opportunity for premium pricing is to have a “branded” product where the brand perception allows for premium pricing. Heinz ketchup is an example. Although there are many types of ketchup on the market, Heinz has the largest market share and can charge a premium price as well, because of branding.
Branding takes time to develop and some branded businesses in Kahnawake include Eileen’s and Homespun. Sometimes you can achieve branding by associating with others who have a recognized brand name, giving you instant credibility. Jacob’s hardware sells brand name products which provide an assurance of quality.
This strategy is usually for the start-up business that needs to develop market share and customers are not aware of the existence of the business and aren’t sure about the quality.
Consumers are always “downside risk” oriented. They are focused on “What happens if it breaks?” rather than focusing on the benefits associated with the product/service. So, a new business must reduce the risk for clients by following a “try it you’ll like it” policy for the early adopters who will influence others through word of mouth.
Many even offer the samples to early adopters as “free” in order to encourage adoption. Coupons and discounting are the usual methods but there are some guidelines:
a) 2 for 1 is better than 50% off because you will get two clients not one.
b) Always use coupons to track marketing and so your regular price is maintained.
c) Always stress for a limited time to avoid procrastination
d) Always have a limited supply of discounts ( e.g. first 50 ) to create a sense of urgency. + consumer competitiveness.
e) Always provide a money refund with no questions asked in order to reduce the downside risk for the early adopter.
This is based on the cheapest price wins. The consumer is not interested in quality, only price. The winner here is the business that can purchase for the cheapest possible price and/or keep their overheads to a minimum.
Normally this is the Croteau, Wal-Mart, Price Costo model. There are instances where a small entrepreneur can compete on price by keeping costs down. Name brand appliances, for example, require lots of floor space to display, need to be located in a high traffic area (e.g. Mall) and require a lot of salesperson’s time to explain features, models, etc.
So, the retailer has high costs of inventory, floor space, rent, salesperson’s salary ( to show and explain the benefits of the product ). Even though they get excellent terms with the manufacturers, their overheads are very high.
A small entrepreneur can sell appliances from a small, low rent location. The appliances brand name gives the entrepreneur instant “branding” (credibility) and the consumer is only interested in price. So, from this low rent location, with no inventory, the entrepreneur can tell clients to “shop around” at the major stores and find the make, model, color and options of the appliance they want. Once they have that then they would come to him/her last for the best price. The very low overhead will offset the volume discounts the major players have.
The business plan should evaluate options for the choice of a location for the business and justify the final decision for selecting the location.
The first step is to determine the trading area for the business. This means the geographic area that the business will draw customers from. In Internet based businesses the trading area can be the world, while a convenience store will usually have a trading area that is halfway to the next convenience store ( unless delivery is provided ). The trading area may be all of Kahnawake or portions of Kahnawake depending on where the customers are clustered. In some cases, the trading area may be dispersed – if you are targeting businesses that want to advertise to Kahnawake ( e.g. Eastern Door Newspaper ) then your trading area can be Kahnawake, Chateauguay, LaSalle, other First Nation communities, etc.
Below is a table that indicates the approximate size of a trading area that will support a particular retail operation. Considering that the population of Kahnawake is around 8,000 you can get an idea of what retail businesses would have an opportunity. Don’t forget to consider the competition – A community of 8,000 could only support one florist ( 7,500 requirement ). If a florist already exists then a new florist would have to “steal” clients from the existing. At some point both may fail because they would each have a client base around 4,000 which would be insufficient to sustain a business for either. Consider also the external competitors ( Chateauguay, LaSalle, etc. ). Although there are no appliance stores in Kahnawake, the leakage survey indicates that almost all appliance sales go to Chateauguay. In this case even though you are the only store in Kahnawake you would not automatically have access to the 8,000 poulation – you would be competing with the Chateauguay retailers:
Population requirements for various types of retail stores
Camera and photography supplies 40,000
Dry goods 25,000
Florist shop 7,500
Grocery store 700
Hardware store 5,000
Hobby/toy store 25,000
Household appliances 8,500
Jewelry store 7,500
Mens’ and boys’ clothing 7,500
Restaurant / lunch counter 1,000
Shoe store 6,000
Sporting goods 12,000
Stationery store 25,000
Women’s clothing 5,000
Once the trading area is defined then you need to consider where you will be located in reference to the trading area. There are some variables to consider when making this decision:
1) Home based operation. This is a logical location since it reduces the expenses, particularly at the start-up phase when you need to conserve cash. This may have problems if the clients will be coming to your business. The image of a home based business does not reflect a professional business operation and your image may suffer. If you go to your clients, deliver, or sell through retailers, a home based location may be ideal for you.
2) Proximity to clients. This may be the most important variable particularly if you have a convenience product/service. If clients want easy access to your business then you should be where they can get to you easily. Often this requires a higher rent location because rents tend to be higher where there is easy access.
3) Proximity to suppliers. If you will be receiving products from a supplier and there is delivery expense, then it may be wise to locate near your main suppliers ( provided you have a long term agreement with them ). This would be ideal if it wasn’t important to be near your customers ( they came for cash and carry ). This would keep your rent low and be ideal for lumber yards and produce stands. Low rent provides a saving when your customer is price sensitive and is willing to travel to make savings.
4) Other factors. In some businesses, access to a skilled labor force (manufacturing), availability of water, sewage, electric, access roads, parking, and a variety of other variables may be the critical decision variables.
The justification of the location can be made as a “decision matrix” . An example follows:
You are going to open an organic vegetable store in Kahnawake. There are no other stores specializing in this and you realize that you need to be close to traffic flow, and have excellent parking because the clients will be impulse shoppers who will see your sign and make a decision to come in and buy. You are also concerned about the cost of the location since you don’t anticipate high sales to begin with.
With this in mind, we have identified the important variables to consider (visibility, traffic, cost ). We can now assign a value to each, based on the perceived importance of each. On a scale of 1-10 with 10 being “very important” we assign the following values:
Parking = 9
Visibility = 7
Cost = 3
We have found 4 available locations to investigate. OCR, Old Malone Highway, one in the village on a side street and we will also consider setting up at home.
We now assign values to each location on the basis of how well it fits the criteria we established. Notice that visibility is highest on Old Malone ( 9) and OCR (6). Costs are lower in home based (9) while parking is terrible in home based (1) and the village (2).
Now we multiply the assigned values. So, the value of visibility (7) multiplied by Old Malone score of 9 on that variable gives a total of 7 x 9 = 63 for that variable. Multiplying all variables by each location’s score gives totals. Adding all totals for a location gives a total score. The highest score justifies the selection of that location.
|Customer parking (9)
( 1 = poor )
|Cost (including renovations)(3)
( 1 = high)
|Visibility – impulse traffic ( 7)
( 1 = poor )
|OCR||5 (45)||5 (15)||6 (42)||102|
|Old Malone||3 (27)||2 ( 6 )||9 (63)||96|
|Village||2 (18)||6 (18)||3 (21)||57|
|Home based||1 ( 9)||9 (27)||2 (14)||50|
This matrix can be put in an appendix to show the calculations and how the decision was developed.
There are some decisions that need to be made regarding the method of distribution of the product/service. Decisions should be based on the expectations of the customer and how they prefer to receive the product/service.
In the previous example we are indicating a customer that is purchasing impulsively and will want to have easy access and parking at the moment they make a decision to purchase. Some other distribution models could be as follows:
1) The organic vegetables are delivered to the clients based on the client phoning in an order after receiving a flyer in the public-sac
2) The organic vegetables are sold wholesale to various fruit and vegetable stores in other communities
3) The organic vegetables are sold at the Gas station in Kahnawake as a kiosk on site
4) The organic vegetables are sold commercially ( hospital, restaurants, etc. ). This is done by personal delivery.
So, you can see that there are a number of potential methods to bring the organic vegetables to market. We have chosen the convenience method in our example – the choice of any other distribution model would have an impact on profits, pricing, volume and location. Delivery, for example, would mean we would not have “visibility” and “parking” as such critical variables in our location assessment.
There has to be consistency between the target market niche, methods of promotion, product considerations ( packaging e.g. ), pricing, location and distribution.
Pricing decisions need to be based on keeping prices low enough to achieve adequate sales yet high enough to ensure profits. It is a delicate balance and it is largely based on:
a) customer expectations
b) availability of substitutes ( competition )
d) type of product/service
Constant monitoring of the market is needed because price is not always fixed – competitor initiatives can require adjustment to your pricing policy as well as changes in supplier terms.
The choice of a suitable location and distribution system is an important decision that needs to be justified in the business plan. A decision matrix and map can be valuable inclusions in an appendix and distribution decisions should be based on customer expectations. Distribution decisions can substitute for the need for a key location.
EXERCISE # 1
For the following businesses, indicate the pricing strategy you would select and how you could implement it:
* A hairdressing salon
* A new art/craft innovation
* A retail store ( value-added re-seller ) VARS
* A delivery service
* A day care center
* A carpet cleaning service
* A garage mechanic
EXERCISE # 2
Select one of the businesses in exercise # 1. Consider the method of distribution, develop location criteria and use the matrix below to assess a few specific locations you would consider:
EXERCISE # 3
Develop a pricing strategy for your business opportunity. Justify your choice.
EXERCISE # 4
Develop your distribution strategy and, using the matrix below, determine and justify your choice of location:
1) You start your business. Suddenly your competitor matches your penetration pricing strategy to ensure that none of their customers go to you. Your business plan is based on capturing a percentage of those customers and reducing leakage. You know that they will raise their price again once you raise yours or when you go out of business. What strategic decisions can you make ?
2) Discuss the implications on distribution and location for:
a) a shopping good
b) a specialty good
c) a convenience good
d) an unsought good