Pricing

Introduction

In the dynamic world of the food industry, pricing plays a pivotal role in determining profitability and shaping brand perception. It is imperative for businesses to understand their target customer segment and create a pricing strategy that works for them. The success of a food business largely depends on the price that customers are willing to pay.

Overpricing can deter customers, while underpricing can lead to missed revenue opportunities. Thus, a well-planned pricing strategy is crucial for the success of any food business.  Many business owners often find that, by adjusting their prices to match the financial capabilities of their target customers, the could raise profitability as much as 20% within a short period.

Knowing the right amount to price products starts with understanding customer-perceived value and the business's operating and overhead costs.

Customer-perceived value

Customer-perceived value refers to the significance or monetary worth that a person places on a product, which ultimately dictates their purchasing decision. To illustrate this point, imagine being stranded on a deserted island without any food or water. After two days of dehydration, a choice is presented to you - a suitcase overflowing with cash or a single bottle of water.

Although the cash may hold great value in other circumstances, the water bottle would undoubtedly be the more valuable option in this scenario. This example highlights how customer-perceived value can fluctuate based on several factors and how it can drastically impact consumer decision-making.

The following factors can influence the perceived value of a product:

1. The state and need of the person: Hunger, for example, can lead to a higher value being placed on food, while a crisis can cause certain commodities to skyrocket in value.
2. The monetary cost of the product relative to substitutes: Another important factor in customer-perceived value is the cost of the product relative to its substitutes. However, this may not be as important if the customer segment is not price-sensitive. Price-sensitivity will be looked at in a little more detail in the next section. 
3. The availability of the product through time: Limited edition products, in particular, tend to hold higher value due to their scarcity. Let's imagine a boutique coffee shop that brews just 20 cups of its signature blend each day. The quality of their coffee is unquestionably superb, and the shop is renowned among coffee aficionados. Because of these factors, the customer-perceived value of their coffee significantly rises. However, a customer who values their time might hesitate to visit this shop, due to the unpredictability of securing one of the limited daily brews.
4. The quality of the product: Quality varies based on the consumer's perspective. As an example, consider a gym-goer. They may not discern between organic and regular protein powder. For them, both variants could represent identical quality. However, they may consider a protein shake with extra vitamins as higher quality than one without. 
5. The global demand for the product: Advertising increases the overall demand for a product because more people know about the business and what it sells. It helps create a brand to which people can relate and seek to associate by buying the product. The more famous a brand, the more people talk about its product. This, in turn, creates more demand and increases the customer-perceived value.

Understanding these factors can help businesses determine whether their customers' purchasing decisions are based primarily on price or perceived value.

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Price-Sensitivity

Price sensitivity refers to the degree to which the price of a product or service impacts consumers' purchasing behaviours. In essence, it reflects how a price change—up or down—affects the demand for a product or service.

The concept of price sensitivity is integral to the effective determination of pricing strategies, as it provides valuable insights into how consumers perceive price changes and how these changes might influence their buying decisions. Understanding this allows businesses to optimize their pricing, maximizing profitability while ensuring customer satisfaction.

Price sensitivity is directly influenced by several factors, including:

1. Substitute Availability: Consumers will likely be more price sensitive if many substitutes are available for a particular product or service. The easier it is for them to switch to another product, the more sensitive they are to changes in price.
2. Perceived Quality: Consumers may be less price sensitive if a product or service is perceived as high-quality or unique. They may be willing to pay more for the product's perceived value.
3. Expenditure Proportion: If the cost of the product or service represents a significant proportion of the buyer's income or budget, they are likely to be more price sensitive.

Price Sensitivity vs Customer-Perceived Value

While price sensitivity and customer-perceived value are both critical factors in pricing decisions, they represent different aspects of the customer's buying decision.

Price sensitivity is about how customers react to changes in price. It's a measure of their tolerance for price fluctuations and the impact these fluctuations have on their purchasing behaviour.

On the other hand, customer-perceived value is a measure of the customer's evaluation of the benefits of a product or service relative to its cost. It's the customer's assessment of what they get (the product's quality, benefits, and additional services) against what they give (the price).

The relationship between these two concepts is complex yet essential. A high perceived value can decrease price sensitivity. If customers perceive that they are receiving significant value from a product or service, they are likely to be less sensitive to price changes. They may be willing to pay more because they see the product or service as worth the additional cost.

However, if customers perceive that the value they are receiving is low, they are likely to be more sensitive to price changes. In this case, even a small increase in price could lead to a significant drop in demand.

Operating & Overhead Costs

Determining the pricing strategy requires considering the operating and overhead costs associated with the product. These costs help ascertain the minimum price that should be charged to avoid losses

Operating costs, also known as direct costs, are expenses that are directly tied to the production of goods or services. In a food business, these costs typically include the cost of goods sold (COGS), which encompasses the price of ingredients and other materials used to prepare food items. Labour costs, such as employee salaries, are another significant operating cost component. Additionally, permit fees, often required for food businesses to operate legally, also fall under this category.

On the other hand, overhead costs, also known as indirect costs, are not directly tied to the production of goods or services but are necessary for the overall operation of the business. These costs include marketing expenses, crucial for promoting the business and attracting customers. Costs associated with upgrades, such as kitchen equipment improvements or dining area renovations, also fall under overhead expenses.

Beyond operating and overhead costs, other expenses can impact the pricing strategy. Interest paid on business loans is one such cost. Suppose a business has borrowed funds to finance its operations or growth. In that case, the interest on this debt can significantly impact its bottom line. Therefore, it's essential to factor in these costs when setting prices.

Another cost to consider is business taxes. These taxes can vary widely depending on the location of the business and the specific tax regulations in place. In some areas, food businesses may be subject to additional taxes, such as food and beverage taxes, which should be incorporated into the pricing strategy.

Markup Pricing

Markup pricing is a widely used tactic in the food industry for establishing profitable price points. This approach involves adding a percentage markup to the cost of each menu item. This markup needs to absorb operational and overhead expenses, while also ensuring adequate profit for the business. The calculation involves multiplying the menu item's cost by the selected markup percentage. This sum is then added to the original cost to arrive at the final sale price.

For example, suppose it costs a business $2.35 to make one meat pie, and the markup percentage is 45%. The sales price is determined as follows:

unit cost price x markup percentage = Markup amount
$2.35 x 0.45 = 1.05 

unit cost price + markup amount = Sales price
$2.35 + 1.05 = $3.4 

Adding Wastage and Time-Value

In real life, two essential elements frequently neglected in food business pricing are waste and time value. It's estimated that food enterprises waste about five to ten percent of their food and ingredients before it gets to the customer. 

Because some waste is unavoidable, especially for fledgling entrepreneurs, incorporating this into the pricing plan is smart. Planning for about 15% wastage is conservative enough during the early stage. This amount will drop significantly with practice, but the markup percentage should be reviewed to cover it.

Similarly, accounting for the value of the business owner's time is crucial. While a six-figure salary might not be the goal, it's important to ensure that the pricing strategy allows for a reasonable income for the founder from the business. Business owners should resist the temptation to short-change themselves and ensure their markup sufficiently covers this.

Balancing Quality and Value

Achieving a balance between quality and value is a delicate act. It is not merely about setting a price; it's about communicating the worth of a product to the customer, justifying the cost, and ensuring that the customer perceives it as money well spent.

Quality, in this context, refers to the standard of ingredients used, the skill and care put into preparation, the presentation of the food, and the overall customer experience. A higher price often signals superior quality to the customer. However, it's essential that the product lives up to this expectation. If customers perceive that the quality of the food and their dining experience justify the price, they are likely to become repeat customers and even advocates for your business.

On the other hand, value represents the benefits a customer receives in relation to the price they pay. It's about offering more for less. A lower price can attract price-sensitive customers, but it's crucial not to compromise on the quality of the product or service. Offering value for money can help attract a wider customer base and foster customer loyalty.

Striking a balance involves setting a price that is high enough to reflect the quality of the product and the effort put into creating it, yet low enough to offer value for money. This balance is not static; it requires constant monitoring and adjustment in response to factors such as changes in cost of ingredients, customer feedback, and market trends.

The art of balancing quality and value in pricing is a strategic process that goes beyond numbers. It involves understanding your customers' perceptions and expectations, delivering quality products and experiences, and ensuring that the price reflects the value offered. When done right, it can lead to increased customer satisfaction, loyalty, and ultimately, business success.

Case Study - Bob's Burger

Bob's Burger Joint, an urban eatery renowned for its gourmet burgers, was encountering stagnant profits despite a thriving customer base. Bob recognised the need for a strategic shift, so he overhauled his pricing approach.

Bob started by reevaluating customer-perceived value. He observed that his signature spicy chicken burger was a hit during local football games, with fans willing to pay a premium for the flavour-packed experience. In contrast, families preferred the classic cheeseburger, valuing its wholesome appeal.

Then, he scrutinized operating and overhead costs. Previously, Bob only accounted for ingredients and labour. But, he realized he had been neglecting key factors like marketing expenses, food wastage, and his own time commitment.

Embracing markup pricing, Bob decided on a comprehensive cost analysis that encapsulated all these factors. For instance, the spicy chicken burger's production cost was $3. With a markup of 70%, considering the high perceived value during game days, the selling price was:

Unit cost x markup = Markup amount 
$3 x 0.70 = $2.10
 
Unit cost + Markup amount = Sales price 
$3 + $2.10 = $5.10

The revised pricing strategy helped Bob increase profitability while reflecting the value customers placed on their products.