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Is the Price Right? Pricing Strategies for Internet Businesses

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You may have the greatest product/service in the world, but you won't get anywhere if it isn't priced properly. In this article, we'll explore various pricing strategies so that you can find the one that is best for your business.

Generally speaking, there are three primary pricing strategies Internet firms employ: POPS, CAPS, and VAPS. Each strategy is explored below. If properly implemented, these strategies can help firms under price their competitors while being just as profitable.

Physical Object Pricing Strategy (POPS). This pricing model works well if you are selling a physical good that needs to be shipped to your customer. For instance, merchants like Amazon.com and Wal-Mart fall into this category.

In order for such firms to determine their prices, they need to start with a base level of what it costs them to produce and deliver one additional unit (this number is known as the marginal cost,). For instance, Wal-Mart sells microwave ovens. What does it cost them to produce an additional microwave oven? What does it cost them to buy it from their supplier, put it in their store, get the customer to come to the store, and execute a transaction with their customer?

To determine their final price, firms should add a percentage increase to the marginal cost. This percentage increase is known as the operating profit margin. To find out what percent they should use, they should look for similar firms, and try to price accordingly. Amazon, for instance, has an operating profit margin of 6% at the time of this writing. Competing retailers should look to have a similar operating profit margin -- preferably lower if they are able to.

KEY IDEA: Firms that can develop the most efficient business processes will be able to minimize their cost, which in turn will allow them to keep prices low while still retaining attractive margins. This will allow them to offer lower prices but still enjoy the same level of profitability.

Cost of Acquisition Pricing Strategy (CAPS). POPS works very well if your primary cost is the cost of the actual good that you are delivering. But firms that are selling a product/service where the primary cost is marketing-based -- meaning the costs associated with getting visitors to your site -- may benefit from utilizing CAPS to determine their final price. CAPS involves firms answering two key questions:

1. What will cost it to get people to my site?
2. What percentage of my site visitors will make a purchase?

The answer to question #1, divided by the answer to question #2, tells the firm its cost per acquisition. The operating profit margin can then be added to determine the final price.

Example: A retailer may find that on average it costs $0.10 to get a visitor to the site, and the percentage of site visitors that make a purchase is 1%. From there, we simply do the math: .10 / .01 = $10. With a cost per acquisition of $10 and assuming competitors have an operating profit margin of 20%, the final price should be set to $12.

KEY IDEA: The key here is obviously to minimize the cost per acquisition. To do this, firms need to place a high priority on increasing the percentage of visitors that make a purchase. The site's conversion rate is the most important metric.

Value Added Pricing Strategy (VAPS). For businesses in which the marginal cost is zero -- for instance, the sale of digital products like ebooks and online courses -- or businesses in which there is not much of an established precedent, VAPS can be an excellent pricing strategy. This is simply a more ad hoc strategy in which the good is priced based on how much value it offers to the consumer. There is no real formula to this strategy, which can be comforting or disturbing, depending on your preference.

KEY IDEA: VAPS works best when you can create a business model that allows you to charge a different price to different clients. For instance, if you are selling consultation services or customized products, you can offer your client a quote based on how much the product is worth to them.

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