Developing Your Pricing Model
In all the hustle and bustle of starting a business, developing an effective pricing strategy is too often overlooked by founders. They get so preoccupied with the product, the marketing strategy and the business itself that they fail to take the time to accurately establish the right pricing mix for their business. As a result, they often fail to maximize their sales because their pricing structure isn’t quite right.
They find out months or years down the track that even a small adjustment to their pricing model, can boost their sales. We hate to see this happen. So, here at Inventor, we emphasise pricing structures from the very start, to make sure our clients are getting it right the second they hit the market.
What Not to Do
Without a doubt, the worst thing you can do, is establish a pricing structure without any justification. It seems obvious, but we’ve spoken to business owners that have simply set their prices as they saw fit and didn’t think to evaluate whether they were the right prices. When established business owners come to us, we make a point of asking about their pricing. And then we ask ‘why’; why have they set their prices to be the way they are? What we’re looking for, is some type of justification for the prices they’ve set, whether it’s based on a desired profit margin or to be a percentage cheaper than the rest of the market.
But when we hear that they’ve set the price that way just because that felt right, our instant response is to recommend reevaluating the pricing structure.
Set Your Prices Based on Cost
Possibly the most common driver of pricing models are business costs. It’s quite a simple method, you calculate the cost per unit of producing the good you’re selling, then you add your desired profit margin. For some businesses, that works absolutely perfectly.
However, it can be difficult to actually accurately calculate the per unit cost of running your business. Sure, there will be variable costs associated with directly producing your product. But there will also be fixed costs that you can’t directly assign to each unit. Things like office rent, subscriptions and wages aren’t easy to narrow down to a per unit cost. Your $4,000 a month rent will be the same regardless of whether you sell 100 or 200 units in the month. That means your rent could either contribute $40 or $20 to your per unit cost. ‘
As a result, you’ll rarely ever be able to perfectly calculate your per unit cost.
Analyse Your Competitors
The other thing you need to keep in mind is the market you’re entering into. Unless your product is a revolutionary new product with no possible existing competitors, you’re going to have to consider your competitors. So, take the time to find out their pricing structures and compare them with your possible options. You need to consider whether you want to compete on price, quality or value.
To compete on price, you want to be setting your prices below theirs (as long as you don’t have to make a loss to do so). Or if you think your product is of a much higher quality than theirs, then you can afford to be a little bit more expensive, as long as your customers understand that they’re getting better quality for that higher price. And of course, competing on value puts you somewhere in between price and quality competition. With a value strategy, your objective is to be the best ‘bang for your buck’ product on the market, either by being market-level quality at a lower price, or being above market-level quality, at a market price.
Now we’re not saying you need to break into your competitors’ office’s and steal their documents on pricing. You can find out most of the information you need with a quick online search and possibly by making an enquiry if necessary.
Analyse Your Target Market
It’s also critical to consider your target market when you’re establishing a pricing model. Take the time to consider their likely budget and willingness to pay for a product like yours. Bonus points if you do some market research to find out exactly what your ideal customer thinks. It’s easy to use Survey Monkey or Google Form to get feedback from potential customers. And of course, you want to hear from the people that are most likely to buy your product and adjust your prices based on that feedback.
Align Value and Willingness to Pay
While you’re conducting your market research and usability testing, whether it’s before or after you’ve developed the product, it’s crucial to differentiate between a customers perceived value of a product and their willingness to pay for a product. There’s quite a distinct difference between the two responses you’ll get. Just because a customer feels like a product is worth a certain price, doesn’t mean they’ll be willing to purchase the product at that price.
When someone considers their willingness to pay, they have to consider their own personal budget, which isn’t really a factor when they consider how valuable something is. Ideally, you want to establish a consistent understand of your target markets willingness to pay, then make adjustments to align the perceived value of the product.
The last thing you want is a product that appears to be really expensive, but customers are never willing to pay that much for. Sure, you could gold plate a toothbrush and customer will think it’s worth thousands, but how many people are really willing to pay that much for a toothbrush?
And finally, when it comes to your underlying pricing strategy, you’ve got plenty of options. In fact, we could write a whole new post just of pricing tactics (and we probably will). Some popular strategies include sandwich pricing (high, medium and low pricing with the objective of getting customers to go for the medium price) and penetration pricing (dropping prices low artificially to help penetrate an established market).
We won’t go into extreme detail on pricing tactics just yet, but the crucial thing to consider is how your pricing structure aligns with your key business objectives. Are you trying to gain market share as soon as possible or encourage repeat customers? Identify your goals and objectives first, and adjust your pricing strategies accordingly.