Wednesday, August 20, 2008

Knowing Your Target Market

One of my MBA students, Judd Taylor, has shared with me an interesting example of a firm perhaps not being fully aware of how its pricing strategy shapes its target market, particularly given the recent run-up in fuel prices. Taylor wrote:

"I recently completed a new stone patio adjacent to the deck on my house. In the process of researching suppliers for the stone pavers, I noticed that one local company offered free delivery for any amount of goods purchased. I wondered how they got away with this given the recent increases in fuel prices. Further investigation revealed that their stone prices were noticeably higher than their local competitors, indicating that they must transfer their transportation costs onto the price of their products. The ability to offer “free delivery” must be an important advertisement for this firm as it is indicated in all of their flyers and brochures. Conceivably, this pricing strategy would appeal most to homeowners who cannot amortize the cost of the delivery over a large order. Contractors might prefer to pay the delivery charge in exchange for a lower price on the materials, especially for large orders."

Taylor's example is an interesting one, because one wonders if the firm understands how its pricing strategy may be shaping its target market. Does the company understand that it will attract homeowners much more so than contractors with this pricing strategy? Perhaps it does, but in some cases, firms may not understand how a particular pricing strategy may shape who shops, and who does not shop, for their products.

How about the implications of oil price increases? Well, a free delivery ad might play well given high gas prices. However, those increases in gas prices certainly will result in higher and higher item prices for the stones, if the firm wishes to continue make profit with its free delivery strategy. This will only drive more contractors away, and it will mean that homeowners with very small jobs will be the most likely purchases of their products. Will this be economically attractive for the firm? What will its cost structure look like with a high frequency of deliveries of small batches of items? The cost of these kinds of deliveries, naturally, is higher than traveling to a job site to deliver a very large order.

The point is simple: Every firm should be clear on how its pricing strategy shapes the kinds of customers who will purchase its product. Does the pricing strategy attract the kind of consumers that a firm wishes to target? Or, is a firm attracting customers which it does not want, or with which they cannot make an attractive profit?