I am often asked how to establish a product/service price. Here are some background thoughts:
- Costs influence price. On a very basic level, price is the markup applied on the cost of the product/service offering. Businesses are not sustainable if costs outweigh the revenue, so figuring out ways to reduce costs in a startup and determining a price that exceeds these costs is crucial. This means the first rule of pricing has to do with the cost of goods. If a business’ suppliers and manufacturers are raising their rates, then an adjust to the business prices must be made to accommodate. Every $1 increase in the cost of goods, means at least $1 lost on the business profit. Review pricing often, and negotiate with vendors to keep your costs low. Things like pre-paying or shortening the pay window may be enough to negotiate lower rates with some vendors. Bulk purchasing may be another option to keep your costs low. But when all else fails, a price increase to the customer may be the best solution.
- Consumers determine price. On the other hand, there exists a certain price equilibrium. If the price is set outside the range that customers are willing to pay, no one will buy whatever is being sold. For this reason, price is primarily influenced by the market. It may be entirely unclear what the willingness to pay is, which should lead to analyzing the competition and obtaining feedback directly from consumers. It’s safe to say that you aren’t the only one in the market. You have competition, and you should keep an eye on what they are doing and how much they are charging. This doesn’t mean that you have to have a lower price than your competition. If you are creating value and have a superior product offering, don’t be afraid to charge accordingly.
- Prices set expectations. On a psychological level, pricing conveys meaningful information. Beyond the principles of supply and demand, price is a sign of quality. Based on proven cleaning performance, I once successfully introduce a product that was priced at 10 times that of the nearest competitor. The consumer expectation was established that our product would clean that much better.
- Prices affect cash flow timing. From an operational standpoint, cash flow is derived from both price and sales. Expected sales will vary as a result of the pricing strategy. For instance, one of the reasons subscription pricing is so popular is because it takes the math out of the customer’s hands and sells the product on higher value, not lower price. Calculate the cost of the pain, show how the offering can remove it, then sell the product offering at a subscription price lower than that cost. This psychological pricing strategy works because it puts the customer loyalty on autopilot. Some are calling this Harvard’s psychology of consumption to deploy strategic pricing. The concept is that by getting customers to commit to a lower rate over a long period of time, you will retain more customers and rake in more revenue in the long-run. In other words, it’s not about what customers pay or even what consumers pay for, but how customers pay. If you are thinking about doing this, be sure that your customer behavior matches the pricing strategy.
Even with these thoughts in mind, determining the price to set for a product or service can be challenging if some historical price and demand data is not available. So be sure to considered the following questions when setting a price:
- What is your cost of doing business?
- What is the cost to manufacture your product?
- What is your break-even point?
- What amount do you need to charge to be profitable?
- What amount are customers willing to pay?
- What are competitors charging?
Now, follow these steps to take to answer those questions:
- Determine your objectives.
Consider whether the price that is set today is driving a short-term gain at the expense of long term success. For example, underpricing the product/service offering may lead to an influx of one-time purchases from customers who are not loyal. If your business relies on repeat purchases, this will undermine its efforts. - Conduct market research.
When breaking into an established market, it is always recommended that you analyze what prospects are paying for similar offerings. So, reach out to potential customers, identify their willingness to pay for the offering, and chart the existing competitors along with their respective prices. - Evaluate your unique selling proposition.
If the offering product/service provides immense value that no one else is able to offer, customers will be willing to pay above market rate to reap the benefits. Knowing if your price is equal to perceived value is crucial in determining whether your product or service is underpriced, overpriced or priced correctly. - A/B test prices for engagement.
As with many different aspects of an early startup, experimentation is often key. When determining what price is most attractive to a consumer, engagement is a useful indicator. Offering the same product or service at multiple prices to different customers is an effective way to identify what works best.
Ultimately, price is more than a number. It conveys value, signifies the earning potential of your business, and plays a pivotal role in countless other decisions. Apply these pricing thoughts to unlock your startup’s full growth potential.
For more thoughts on product/service pricing, browse the “Thoughts Library”.
Copyright ©John Trenary, 2022