An area that people get wrong all the time is pricing. Some people price high based on the profits they hope to achieve. Some base it on some sort of average industry “cost plus” rule. Some are afraid to charge too much. Still others simply add a few percent to last year’s price. So before you set your next price or quote your next deal here are the 5 Golden Rules for pricing.
1. Cost. (Thank you Captain Obvious): You have to know your costs. And you have to know the difference between gross profit and net profit. Gross is the profit left after the cost to create the product or service. Net profit is what’s left after you’ve paid for the product and delivered it (including cost of sales, delivery, installation overhead, etc.). In most cases - but not necessarily all - you’ll want to price your product above your cost. With your costs understood you’re well on your way but please don’t simply add a fixed percentage. Sure it’s easy “cost plus 30%” but you could be leaving a lot of margin on the table. Read on.
POP QUIZ: Cost + 30% = 30% margin. Right or wrong? The answer is below
2. Value. This may be a bit trickier, but you need to know what value your customers will derive from the product or service you are providing. Take the example of a person dying of thirst in the desert. If they value their life, they’d pay everythingthey have for a glass of water. So while you could charge up to the value amount, you do need to leave some value for the customer; otherwise, there is no motivation for them to buy.
3. Affordability. If you were to charge more for that glass of water than the dehydrated desert traveler happened to have, the deal could not be done – no matter how much they wanted it. If they can’t afford it, they can’t buy it.
4. Comparisons. People want to make sure that the price is reasonable. If someone else is selling exactly the same product and service, the lower price wins. However, it is almost impossible to sell exactlythe same product. Maybe your packaging is different. The customer might like one sales rep more than another. Yours is delivered by courier and the other one is sent by carrier pigeon. No matter what, people will always compare, and to buy from you they will need to be able to rationalize the delta (plus or minus). When selling, we can help by suggesting what they might compare our offering to. (As consultants we often explain that we are professional consultants and not simply ‘people between jobs’.)
5. Market Size. The last consideration is a bit more esoteric. If your price falls into that area that’s above your costs and compares favourably with others, then you need to think about market size. The closer you price to the maximum value - the fewer people will buy. The B-School term for pricing high is skimming– getting huge margins from early adopters who really, really want your product or service. The lower you price, the wider the potential market is albeit at lower margins. Of course, your ability to produce, the impact of production volumes and the length of time your product will remain relevant, are the defining factors here.
So, when looking at price, remember: it should be greater than your cost, less than the value derived, affordable for the target market a function of the comparators and driven by market size.
Or if you work better with equations:
Price > Cost
Price < Value
Price ≤ Affordability
Price = f(Comparators, market size)
POP QUIZ ANSWER:
$1 cost plus 30% = $1.30. So margin = $0.30 which is .30/1.30 = 23% margin.
Did you get it right?