There are several ways of pricing your product of service.
The methods most commonly used are
- Cost-plus pricing
- Market-based pricing
- Individually negotiated
- Value-based pricing
Of these cost-based-pricing is probably the most common. You work out how much the product costs to make, add your standard margin and ‘voila’, there is the price. Simple. The problem is that you may have been able to charge more, and if so, you are losing potential profit.
Market-based pricing means looking around to see what everyone else charges and then doing more or less the same. This is also easy to do, and usually fairly safe, but to be cruel, one could say that you are letting your competitors set your prices. It may be OK, and may be all that the market will stand if yours is a me-too product, but if it is not, you may be under-selling it.
Individually negotiated prices are common with large one-off items or when selling to large customers, i.e. to customers who potentially have more power than you do. The people who do the negotiation are called sales people, and typically all they care about is getting a sale (and their commission), and the easiest way to get a sale is to drop the price. Hence this also is probably a less profitable method
In other words how much benefit would they get from buying your product, and therefore what it should be worth to them, thus giving the price that they would be willing to pay.
The problem is that working this out is not necessarily easy and different customers may have different requirements and perceptions of value. Therefore you may have to do some market segmentation profiles and some price-volume sensitivity studies to understand this and you may have to offer a range of products at different value (price) points.
Assuming that you can assess this reasonably correctly, the next problem is convincing the customer that your product will actually give them the value that you say it will. If you are a new boy on the block, or have previously been associated with cheap and cheerful products, you will probably have a hard time convincing them. You will either need some very clever advertising (though just telling them probably still isn’t going to persuade them), or to make it low risk (money-back guarantee or some other risk mitigation offer), or to offer some new really cool feature that no-one else has, or to get a powerful endorsement from someone people will believe. Eventually if your product is as good as you say it is word will get round and things will take off, but you may be out of business by then.
Things are much easier if you already have a ‘name’. Then they know (and hopefully trust) your brand and will much more readily sign up to your value proposition. If they really love your brand then they will believe that your are offering the value that they want even though in reality you are not, other than the value of showing off to their friends that they have got the latest ‘X’, whatever it is. This is brand value, which allows a premium over the value-based price that anyone else could get for exactly the same product. Some people will see it as a con and not buy it out of principle. That is why I never buy an Apple, except from a greengrocer, but most people will be taken in by the hype (sorry brand).
Of course there is a danger that you have vastly over-estimated the value and therefore priced it too high and no-one buys it. Well you can always reduce the price to get back to market pricing and you will just be back to where you would have been – Except if in your enthusiasm you let the costs get too high. Then you are in trouble, since no-one wants it at the high price, but you can’t afford to drop the price to something more sensible, because then you will make a loss. In this case unless you find a magic wand very smartly, you will be out of a job and your company out of business – but you can always send an email to the guy who persuaded you to do value-based pricing telling him what an idiot he was.
So the answer is that you need a combination of Value-based Pricing and Target Costing, so that you always have room for manoeuvre and you never get into a potential loss-making situation if you get the value wrong.
Contact us if it seems like this approach has some potential in your situation.