The Art of Pricing Poorly
When a business looks to price their goods or services, often there is too much guesswork. Owners make decisions based on feelings rather than pricing based on the data and the value created by that good or service. For customers who have struggled with profitability, this is one of the top questions we ask. “So, what ARE you charging for your good or service?” More often that we’d like to admit, our customers answer that it was indeed a gut decision, versus a data and value based decision. With respect to our current customers (and future ones too) here are three areas where we see customers price poorly and what you can do to save your business from lost profits.
1. Underlying Costs: What am I Really Spending on this? Before you determine your prices, ask yourself, “What will it cost me to sell the good or service to my customer?” Regarding these costs, you should be looking at everything that is directly related to the sale and is variable. Variable meaning, “Each time I sell my good or service, I incur this cost.” Costs for goods include, the direct materials that went into producing the good as well as the direct labor used to make or sell that good. After you identify these costs, a desired profit margin can be assessed. It is the same with services, however, there usually is not a significant direct material cost involved. It’s important to remember this process does not mean wading into the waters of complicated cost accounting (by which each expense is allocated to determine the cost of an item). You are solely focusing on the direct variable costs associated with each sale.
Ultimately this exercise forces you to understand what the minimum price at which you can sell a good or service.
2. Value Based Pricing: How much worth does my customer see? When you sell a good or service, the customer is willing to pay a price in excess of the cost associated to produce that item. If you go into a sandwich shop, the cost of the bread, meats and vegetables, as well as the labor to produce that sandwich might only be $2. You are willing to pay $8 because you were able to go to the shop, order the sandwich on demand, and within minutes have the food ready for your consumption. Value for the customer was created beyond covering your costs or desired profit margin. This is true of any business. If you do not understand the value created, then you are not capturing that value in your price. You can read more about value based pricing here.
3. Market Pricing: What is reasonable and how am I different from the competition? If you are selling a service for $200 and everyone else is selling a similar service for $50, it’s unlikely that you will be able to sell in a quantity at that price. However, what usually tends to happen is the opposite. You are selling the service for $50 when everyone else is selling it for $200. It’s important to understand the market, how you differentiate your goods or services from your competition, and price in a way that makes sense considering these two factors. Your customers will be making assumptions about your good or service based on your pricing as compared to your perceived competition. Pricing without thinking about your market can result in pricing yourself right out of a sale.
Pricing is a difficult exercise. Guesswork or gut instinct may result in you leaving money on the table, or pricing in a way that does not capture your value. Pricing based on underlying data and an understanding of the current market conditions will do you well and lead to greater profitability.