With so many variables affecting price, how do you know what to charge for your product or service? Business advisor, Alek Marfisi offers up some helpful insights when considering pricing.
Many small businesses face big challenges when deciding what price they should charge for their product or service. The problem stems from the fact that there is just no clear-cut solution. Pricing ultimately comes down to a qualitative rationalization between multitudes of factors, and truthfully, many businesses do not charge the optimal price.
From a business school perspective, a business should charge a price such that their marginal revenue is equal to their marginal cost. Essentially that means pricing a product or service at a point in which the money you make when you sell an additional unit is equal to the expenses associated with selling that additional unit. In a perfect world, this is the best way to price your product because it maximizes your profitability. However, you should also consider the following components of pricing:
Ultimately the name of the game for any business is to maximize the difference between the cost of producing a good or service and the revenue generated from selling it. Cost-based pricing keeps this relationship in mind, often setting price based upon a fixed margin above the cost per unit. While this is a simplistic way to come up with your pricing, there are very few businesses that can solely price based upon this method – mostly companies that have very few competitors. The main problem with cost-based pricing is that it fails to take into account the consumer’s role in the business ecosystem. In order to determine a more accurate price, entrepreneurs must first ask this one question: “Do the consumers think that this product is worth this amount of money?”
A more effective means of pricing your product, value-based pricing looks at the benefit that the consumer is receiving from purchasing a product or service. This is critical in the realm of B2B sales and is the standard in this realm of business. The factors that constitute this value include the time that you are saving your customers (versus if they were to do what you are offering themselves), and the amount that they are reselling your product for on the market (or alternatively, the price that they are selling their product/service for that your service directly contributes to).
A practical means of price setting
Ultimately the price that you set for your product or service will come from rationalizing the two pricing schemes mentioned above and mitigating your price based upon your competitors’ decisions. This process of determining the appropriate price for selling goods or services is a learning curve. It’s important for owners of startups to approach the situation keeping in mind that they WILL start with the wrong price, and from there, make improvements.
Setting prices is very difficult to begin with, but it can be even more of a challenge when you intend to augment them. Case in point, when Netflix increased their monthly subscription charge, they experienced a significant loss of business. Remembering that a startup company will invariably start with the wrong price and work toward the market-effective price (by conducting price discovery), business owners should launch their product/service with a small test group. This group enables the business owner to sell to a small section of the market without fear that the market at large will mistakenly accept this tested price for the final price. Secondly, a controlled group allows the entrepreneur to make material exchanges with the test consumer in addition to the price they are charging. For example, an entrepreneur gives their product/service to the test customer in addition to some free ancillary services in exchange for participating in the test group. During this time, the startup owners may discover that the market at large will support a higher price. The entrepreneur now has the leverage he or she needs to either take away the bartered product/service or increase the pricing on the test customer. These invaluable material offerings effectively allow the entrepreneur to have a give-and-take relationship with the test customer.