This post originally appeared on LinkedIn and it is republished with permission.
In the translation industry two pricing techniques seem to dominate: cost plus and competitive pricing. Before looking deeper into these and other pricing techniques, it is important to remember that price is one of the P’s described by Philip Kotler as the fundamental elements of every marketing mix. In a market that has matured over decades, it may surprise that price often is a frustrating factor. Fierce competition, sophisticated buyers and the resulting commoditizing of the translation activity may explain a lot. Whether a language service company is highly profitable or struggling to survive depends not only on the other P’s of the marketing mix, on corporate culture, sales force or even on technology. An inadequate pricing technique may annihilate efforts in the other critical success factors. In other words, the importance of using a pricing technique adapted to a specific business model cannot be overrated. Price is, with the other P’s, a business variable over which companies can to a certain level, exercise control.
Many translation companies opt for mark-up pricing and switch to meet-competitor pricing as soon as the buyer requests such a move or as soon as they are aware that their offer is being compared. This rationale may not be bad in itself, but leads to frustration every time both pricing techniques prove insufficient to conquer new customers or obtain a much necessary or expected project.
Cost plus pricing, also known as markup pricing, basically is a simple method of taking your cost and adding a desired profit margin to the unit cost price to obtain the final price. The formula below helps you to calculate the unit cost price:
Unit cost = (variable cost) + (fixed cost) / unit sales
E.g. a translation agency with fixed costs of 100,000 € that buys its translations from freelance translators at a unit price of 0.075 € /word (variable cost) and projects to sell 1,000,000 words:
(0.075 €) + (100,000 €) / 1,000,000 words = unit cost 0.175 €
Now that the unit cost is known, the markup or cost plus price can be calculated using the formula below, and assuming that the translation agency defined a desired return on sales of 20%:
Cost plus price = (Unit cost) / (1-Markup percentage)
Using our example from above, we would arrive at the following markup price:
(0.175 €) / (1 – 0.20) = 0.218 € cost plus price.
The translation agency in this example, at a volume of 1,000,000 units, has to sell every unit at 0.175 € to break even and at a price of 0.218 € to achieve its sales return targets.
This pricing technique is fast and easy to use but has a major drawback: it does not take into account customer demand. Customers may be willing to pay more … or less for the service than our translation agency is proposing using the cost plus technique. Another possible disqualifier for this technique is the arbitrary definition of the markup percentage. This pricing technique is similar to the target-return pricing where a company-defined return on investment is aimed at.
While many translation agencies have started out with the cost plus pricing technique, they end up applying the competitive pricing technique, also known as going rate pricing.
Competitive or going rate pricing, is a concept where companies define prices using the going rate for products/services as established by its competitors. Often applied in competitive markets with little differentiation between suppliers and consequently plenty of substitutes. Among translation agencies, it is well known that large, sophisticated buying organizations preselect similarly qualified suppliers and then choose the most competitive supplier among these ‘equal service offers’ or ask a preferred supplier to align its prices on those of a competitor. Many translation agencies will try to gather business intelligence on their competitor’s price and will align their price to get projects.
The main disadvantage of this pricing technique is the disconnection between price on the one hand and unit cost and desired return on sales or ROI on the other hand.
There are other pricing techniques that offer interesting alternatives to cost plus and competitive pricing, not in the least thanks to a better balance between the constitutive elements of pricing.
Penetration pricing, is part of a strategy which uses a lower price than many competitors to gain market share as quickly as possible. The logic behind penetration pricing is that of a powerful vision: the company with the largest market share has superior power in the market, and can achieve greater profitability than smaller players… if it can benefit from economies of scale to reduce the unit cost. Companies applying penetration pricing may want to seduce customers by a low price and connect the basic service with more expensive products/services.
A strong argument for this pricing technique is the rapid increase in sales volume. And once companies buy from a supplier offering the lowest price, they have proven to be reluctant to switch to a competitor even if prices begin to rise.
A major risk of this model lies in the lower profitability on the short term. Low prices may also pave the way for a price war with cataclysmic effects on profitability.
Tiered pricing or good-better-best pricing differentiates price according to levels of feature or quality for products/services. An example used by certain translation agencies:
Tiered pricing is used mainly to cater for varying levels of requirements within the same market. This technique enables customers to choose the exact product/service that fits their needs or budget and they know exactly what to expect. If you apply tiered pricing to complex services, the value of the different levels may become blurred – and your customers may need to be educated.
Perceived value to the customer or Value-in-Use pricing is based on the product/service’s value to the customer. A good example is a product or a service that is higher priced but that can arguably reduce overall costs on the long term. The price is disconnected from the cost (unlike cost-plus pricing) and enables companies to raise profitability on products/services that provide real value to buyers. It is crucial to understand the customer benefits and to translate these in financial terms. A well-known example in the translation industry is the use of CAT tools such as translation memory. At a higher word price, a translation agency making use of translation memories will reduce the number of new words to be translated and thus the overall cost for the customer, compared to a translation agency who with no CAT tools retranslates every word every time at the same price.
Variant pricing is a very interesting technique since it takes into account that different markets have different priorities and evaluation criteria. The general idea is to adapt the price setting to different market segments. In the translation industry, it is a well-known fact that medical device manufacturers, financial institutions, manufacturers of tooling machines, and government institutions, to name but a few, have different requirements when it comes to quality, reliability and speed of delivery, budget, project management and communication, etc. Variant pricing helps us to capture the value different market niches place on their specific requirements. Special variants often offer great freedom in pricing with little competition. A requirement to apply variant pricing, is to have conducted thorough market research.
There are many other pricing techniques, not all of which seem of interest for the translation industry. In terms of conclusion to this brief overview on pricing technique alternatives for translation agencies, price can be defined as a value that will buy a finite quantity of a product/service. Price is determined by what a buyer is willing to pay, a seller willing to accept and competition allowing to charge. Pricing also has an impact on organizational goals and it is important to fully grasp these consequences.
(c) Ralf Van den Haute 2014
Philip Kotler: Principles of Marketing
Michael E. Porter: Competitive Advantage
Stephan Sorger: Marketing Analytics
Paul W. Farris, Neil T. Bendle, Phillip E. Pfeifer, David J. Reibstein: Marketing Metrics