Pricing a product (or service) is hard, and there’s no set way of doing it – but there are few things to bear in mind.
Cost Plus Pricing
If it costs you $100 to make a product, it might make sense to price it at, say $120 to give you a $20 margin. This does form a useful floor to pricing – if you determine that it costs more for you to produce something than you can sell it at, then you’re in deep doo-doo. But it’s generally a dumb idea to use this alone for pricing. Here’s why.
Value to the Customer
Let’s say that someone buys your product for $120 and uses it directly to make $1000. Suddenly you realise that you could have charged $900 dollars and they would have bought it. In fact:
Price you can charge = value to customer – pain in the ass of using it
The hard part is quantifying that value and pain in the ass. If you’re selling information, or education, the value a customer will gain depends entirely on how they use it. And whatever your product, their perception of their pain in the ass of using it can be changed wildly by how well they know you, whether you can provide support, whether they’ve done it before, and so on.
If you are selling information, you can try to determine its value by estimating how it might change a decision by your customer.
For example – let’s say your customer wants to make an investment of $1000, but isn’t sure what it will return. They estimate a $1500 return with a 50% likelihood and a $500 return with a 50% likelihood, so their expected return is $1000 invested, and hence they aren’t going to bother investing anything. If your information tells them that it’s all good and it actually is a $1500 return per $1 invested, they can make the investment, and will make $500. Hence, $500 is the value of your information (minus the pain in the ass factor.)
Now – I know that’s awfully academic, but we can make it more solid. Let’s say your customer is a construction company, and they are thinking about starting a project which depends on a government permit. If you can help estimate the likelihood that the permit will be granted, you can change those probabilities, and turn a guess into a well informed decision.
Pricing to Competition
That said, business is way messier than that. It just takes too much time to exhaustively estimate every factor that goes into a decision like this (unless you’re dealing with millions of dollars, in which case it probably is a good idea.) So, as a rule of thumb, you can look at what the competitors are pricing at. If a customer can find an alternative to buying your product that’s cheaper, they’ll take it.
More. This is especially true if your product is a commodity (i.e. all the alternatives look just the same, like salt.) But if you can put something in your product that no-one else can replace – a differentiator – that means that you don’t have to worry as much about pricing to the competition. That differentiator could be habit, brand, a relationship or something else.
With all of this, bear in mind that you should always be looking at things from the perspective of the customer. Coke famously installed temperature sensors in their vending machines so that they could raise the prices of the drinks on hot days. It’s completely logical – there will be more demand on hot days, and the value of a cool drink on a hot day is definitely higher than on a cool day. But it just plain annoyed customers who felt they were being gouged (and they were), so people didn’t buy out of principle.
- Pricing to cost forms a useful pricing floor.
- Try to determine what value the customer gains out of your product.
- If that’s too hard, figure out what their alternatives are.
- Differentiate your product if you can.
- Don’t forget to think about the customers.