How to Determine Price
February 1st, 2013 // 1:09 pm @ Million Dollar Methods
One of the most critical decisions in running a business is setting prices. Yet most entrepreneurs spend little time deciding, evaluating, and tweaking what they charge.
This exercise is just as essential if you are launching a new product or service, or if you question the price you’ve already submitted to the market place. Later in the series, we’ll address how to raise prices and strategically reduce prices; again actions that all require careful consideration. For now, let’s focus just on determining the optimal price. Note: we are looking for the optimal price where profits are maximized, not the maximum price at which we can convert sales.
Setting the price too high and you can’t sell enough to reach critical mass (the point at which it makes sense to offer a product or service; generally a break-even-point but not always).
But setting the price too low is just as critical of a mistake. You not only leave money on the table but you restrict the amount you can spend on marketing to acquire customers (ultimately limiting the number you can sell or the spend at which you acquire new customers). Don’t assume lower prices equate to more customers, you have to account for marketing expense.
The first step in determining price for a particular good or service is identifying the role it plays in your overall business model.
Is it a loss leader to bring in new customers and initiate the relationship? Or, it is the ‘money maker’ for your business where you generate most of your profit?
Let’s continue with the assumption this is your ‘money maker’ where you need to extract as much profit as possible.
There are four areas of research to explore to collect some data in order to determine your optimal price…
1) Direct Competitors’ Prices: Companies offering the same (or very similar) products/services and selling to the same market. This is the most obvious one and unfortunately about as far as most business owners extend their research.
As an example, let’s take a software company that created an accounting application for golf courses. They would research what others’ are charging golf courses for accounting software.
2) Common-Customer Prices: Companies offering different products/services but selling to the same market.
To continue with the above example, this would include companies that still sell to golf courses but with different products such as: marketing software, point of sales systems, sprinkler control computers, and so on.
The advanced tactic to collect for accurate data is to find companies that sell different products to the same market and to solve the same underlining problem. The golf course account program solves the problem of business operations and efficiency – so what are golf course paying other companies to stream business operations. Perhaps it’s tee-time management software. The common thread is, if they are willing to pay $200 per month to save 10 hours of employee labor; they likely make that same buying decision to save even more time.
3) Common-Product Prices: Companies offering the same products/services but selling to a different market. Essentially operating in a different niche than your company.
Again, the golf course accounting company would review other accounting programs with niche customers. Accounting programs for pet businesses, hair salons, hardware stores, etc.
Be careful here as point #4 is the most critical. Often times customers pay what they can afford. Products for end-customers with drastically different economics will not translate. A golf course may net $500,000 a year while a pet groomers nets $50,000. What they will pay their vendors varies just as much.
4) Customer Worth or Value: The most important fact to calculate is: what is the product/service worth to the customer. Can your business save or earn their money? This is called ‘money at a discount’.
Think about high-efficiency windows that save on utilities, more condensed detergent that last 3 times as long, radio ad spots that double the number of new customers, golf course accounting software that cuts CPA fees in half.
No single data point will give you your answer. The goal is to add as much science into the art of pricing as possible.
The number one piece of advice when pricing a new product/service is: you never want the price to be THE reason it doesn’t sell. Error on the low side to ensure the customer has a need for your product/service and you’re marketing is converting. You can always raise your price later.
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