The profit of the practice is governed by the price of products and costs of operation. Profit, of course, must be the reason why the practice exists, as without it the practitioner will go out of business and not be able to continue to serve patients. The profit drivers for the practice are sales volume, price and costs. Dolan and Simon (1996) present the simple formula:
Profit = Sales Volume X Price - CostsThis formula summarizes the fact that profit is generated by the units of product sold times the price for which each unit sells minus the costs that were incurred to make the sale. A hearing instrument example applied to this formula would be that profit is dependent upon the number of instruments sold times the retail price of hearing instrument to the patient minus the cost of the hearing instrument, clinical fitting time, warranty follow up, marketing, clerical assistance and other general overhead costs. Although this may seem like a simple paradigm, there is more that goes into a pricing analysis than simply how much money the clinic chooses to make, what the competition charges, or mere suggestions from the manufacturer. The key to successful pricing is to know the value of the product or service to the patient.
In the business world, price is often the centerpiece of strained relations with good customers; the weapon competitors use to steal market share; and the source of conflicts within companies. Pricing is the issue that takes precedent over all others relative to profitability. Yet, this is an area where most general business executives receive only a cursory orientation in their educational programs. Although most business references agree that pricing is part of an overall marketing program, it seems that even among pricing specialists there is substantial variance in how prices are established. Therefore, if MBAs of major corporations feel ill prepared to set prices for their products, there is no doubt that the audiologist needs to review pricing fundamentals. Often, accountants with spreadsheets, pro forma income statements, and knowledge of costs have different idea of pricing from those that are customer contact people.
Here lies a major problem in pricing strategies within an Audiology practice; clinicians are primarily the patient contacts. It is well known that those that have contact with consumers tend to price products and services lower (Dolan and Simon, 1996). Although they may or may not see the numbers, margins, profit statistics or the bottom line, they see patients each day. Listening to their stories, presenting options for hearing instruments and other clinical situations can taint the practitioner's judgment as to the prices patients are willing to pay for goods and services. No matter if you bundle or unbundle your prices this article will provide some fundamentals on how to set the prices for your practice. At this point it is necessary to ponder some questions:
- How have you set the fees and prices for your practice?
- Were these prices set according to sound business policies or by simply charging the going rate for products and services?
- Do you know the fair value of the products and services that you provide?
- Do the prices charged in the practice set position of the practice in the community?
Fundamental Pricing Concepts
Pricing can be thought of as beginning with a survey of the situation. A thorough evaluation of the "lay of the land" or the "big picture" using some basic fundamentals procedures must be conducted to arrive at the right prices for the consumer and the practice. Nagle, R. Holden & R.K. Holden (2002) state that, the pricing of goods and services is a balance between the customer's desire for a good value and the firm's need to cover costs and earn a profit. They present three general pricing strategies incorporated routinely in business and by Audiology practitioners: cost-plus pricing, customer driven or value pricing and competition pricing.
- Cost-Plus or Mark-Up Pricing
Cost-plus or Mark-up pricing is the most common pricing scheme for products since it offers an aura of financial prudence to practitioners. Financial prudence, according to the cost-plus theory, is achieved by pricing every product or service to yield a fair return relative to overall costs that are fully and fairly allocated. Kotler (2001) feels that with cost-plus pricing practitioners can determine costs easily and simplify the pricing task. On the surface, cost-plus pricing seems to be fairer to both patients and practitioners than other pricing strategies and appears to be a simple guide to profitability. Nagle et al. (2002) feel that in reality cost-plus pricing is a blueprint for mediocre financial performance. Even though this is the most popular method of pricing for products and services in Audiology, Staab (2000) indicates that cost-plus pricing is often the least rewarding.
A review of the problems with cost-plus pricing begins with a look at real costs. There is a problem in finding a product's real unit cost before determining its price. That is, product costs often change relative to the number of units sold. For example, if you order one or two hearing instruments per month there is a minimal discount, but if 20 or 30 per month are ordered a much larger discount is realized. If a true cost-plus or mark-up pricing system is instituted, there is one price for products that have a marginal discount and another price for those that have a major discount based upon volume sales. If patient demand goes down, then the price goes up, if patient demand goes up the price goes down. Thus, true cost plus pricing is difficult to achieve and leads to overpricing in weak markets and under pricing in strong markets. Of course, Audiology practices can use buying groups and other methods to reduce this patient demand/price difficulty, but problems still arise in keeping up with actual costs.
Costs for products, not only rise and fall across manufacturers, but some clinicians take more time, and some points of delivery (locations) have higher costs than others. Thus, the literature suggests that if cost plus pricing is used at all, it should only be used to set the minimum price to charge (Dolan and Simon, 1996; Staab, 2000; Nagle et al., 2002). - Customer Driven or Value Pricing
Customer or patient-driven pricing is sometimes also called "value-based pricing" and is another method by which practitioners can price products. Audiology practices often use this method for products such as hearing instruments, pricing them in a tiered format where some products are offered at low prices others at medium prices and still others at high and premium prices. This tiered format offers patients a menu by which they can purchase a device that fits into their budget. Once the tiered format is presented, the patient chooses how much they are willing to trade in payment for the benefits of the higher performance product. In Audiology, the use of this pricing method requires significant counseling to offset normal patient opposition to products at a higher cost level by presenting the performance benefits of the higher level instruments. The problem with this method from a business standpoint is that if all of the patients choose products from the lowest level there is significant compromise of the margin (and therefore, practice profit) obtained through product sales. Most Audiology practitioners realize that patients are very naive consumers and do not really know what the audiological products are worth relative to the benefits that they will offer. Thus, it is best to provide the counseling necessary so that consumers understand the real benefits that go with each product tier. - Competition Pricing
Competition pricing, sometimes called "strategic pricing" is also referred to as the "tail wagging the dog" or "follow the leader" pricing (Hosford-Dunn, Dunn & Harford, 1995). This concept is often used by practices attempting to increase their market share, as increased market share is often mistaken as a method to produce increased profit. Sometimes practitioners will lower their prices to gain market share with the idea that the increased volume in sales will offset the lowered prices. Nagle et al. (2002) hold that prices should be lowered only when they are no longer justified by the value offered in comparison to the value offered by the competition. Although price cutting is probably the quickest, most effective method to achieve a sales objective, it is usually a poor financial decision. Since a price cut can be so easily matched by the competition; it offers only a short term competitive advantage at the expense of permanently lower margins. Although product differentiation, advertising, and improved distribution do not increase sales as quickly as price cuts, their benefit is more sustainable and therefore usually more cost effective. Hosford-Dunn et al. (1995) indicate that looking to the competition is a dangerous method of selecting pricing, since the competition may have an unrealistic price for their products relative to their business costs and this cost can be drastically different when applied to another practice where business costs are not the same. While it is necessary to be cognizant of competitive prices; using the prices charged by others in another business, where fixed and variable costs are probably different than your practice is not sound business strategy.
As an alternative to the three methods suggested by Nagle et al. (2002), pricing can be used to position the practice in the community and foster an image for the practice. To be known as the expensive clinic or the reasonably priced clinic, or the low priced clinic can be of benefit depending upon the market conditions. Dolan and Simon (1996) describe the procedure outlined in Figure 1 as a method by which the practitioner can look at the value of the clinical product presented to consumers by the practice. It describes the central role of perceived patient value to position the practice in the community.
Figure 1. Positioning Practice by Pricing. Note. Figure adapted from Dolan and Simon (1996).
Since the correct price for the products of the practice lie in the value consumers attach to them; once discovered, this value offers patients the opportunity to pay a fair fee for services rendered and/or mark up of products. This patient perceived "fair value" accommodates their natural opposition for the purchase and affords the clinic the maximum amount of profit. Dolan and Simon (1996) describe Figure 1 as an essential exercise to arrive at the correct pricing scheme for a practice. At the top of Figure 1 is the practitioner's initial competitor and consumer analysis. As the practitioner reviews the competitor analysis, it is an opportunity to collect the rewards and attributes of the competitor's brand of Audiology currently offered to the market. The competitor analysis is essentially a product differentiation that reviews how this practice can produce the attributes that consumers will find uniquely valuable relative to the other practices or stores that, in their opinion, might offer the same products and/or services. On the other side of the figure, the consumer analysis identifies the wants and needs of the patients in the segment of the market that uses Audiology services and serves as feedback for the probable acceptance of the brand of Audiology to be offered. Once these critical evaluations of competition and consumers are completed, the information is incorporated to evaluate the practice's market position, select the target market, and the value-creating elements of the marketing mix.
Positioning is a process that includes communication with the market. It is an exercise that determines if the practice will be looked upon as high end, mid range or low end. To some extent the price of products and services determine the position of the practice in the group of Audiologists, Otolaryngologists, commercial hearing aid dealers and others offering what patients perceive as the same or similar products. The practice's position, though ultimately determined by the patients in the marketplace, is greatly influenced by the strategy utilized to differentiate it from the competition. Sometimes price is an important component of positioning as patients tend to think that all of the possible places that they can obtain hearing care are essentially the same. The prestige of being a patient in the highest priced place in town or the value that is received by seeking products and services in a practice where products and services are low priced, serve different groups of patients. As the practice is positioned, it may be that if a low price strategy is chosen, volume can be higher to offset the reduced margin or if the practice chooses a strategy for higher prices, the high prices offsets the reduced volume of products sold. It is this perceived value by the patients, according to Dolan and Simon (1996), generated by the pricing strategy and the offerings of competitors that determine the real value that a patient perceives in the products of the practice. This patient perception of value is the maximum price that they will pay for these goods and/or services. Knowing these values for members of the target market demonstrates the essential trade off between pricing and sales volume and often decides the position of the practice within the market.
To complete the model in Figure 1, it is a wise practitioner that knows the competition (the dotted line in the model). A thorough understanding of the competitor's cost structure, capabilities, and business model are essential to value pricing as well as tracking the competitive reactions to the practice's position. Once the initial prices are determined, it is necessary to capitalize on the practitioner's market knowledge to update them regularly using the same process to accommodate the ebbs and flows of the Audiology market situation.
Summary
Pricing of products and services is critical to the success of an Audiology practice and can make the most difference in the bottom line of a practice. Most clinicians have difficulty assessing and applying the correct pricing to the products and services in their practice. This discussion suggests that the correct price is the value placed on the service or product by their patient and offers a model for arriving at the real price a patient will pay for a service or product. Further, it offers an argument that price can be a major factor in the portion of the market served, in that, clinics can be placed in the high end, mid range or low priced segments. Pricing toward the population the practitioner intends to serve can sometimes be more successful in positioning the practice within the community as a part of other marketing functions.
References
Dolan, R, & Simon, H. (1996). Power Pricing. New York: Free Press.
Hosford-Dunn, H., Dunn, D., & Harford, E. (1995). Audiology Business and Practice Management,
San Diego, CA: Singular Publications.
Kotler, P. (2001). Marketing Management. Upper Saddle River, NJ: Prentice Hall.
Nagle, T., Holden, R.K. & Holden R. (2002). The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making. 3rd Ed., Upper Saddle Rive, NJ: Prentice-Hall.
Staab, W. (2000). Marketing Principles. In Hosford-Dunn, H., Roeser, R., & Valente M. (Eds). Audiology Practice Management. pp. 150-159, New York: Thieme.
