Pricing your product or service is one of the most important business decisions you will make. You must offer your products for a price your target market is willing to pay - and one that produces a profit for your company - or you won't be in business for long. There are many approaches to pricing, some scientific, some not. Here is one framework for making pricing decisions that takes into account your costs, the effects of competition and the customer's perception of value.
- Cost is the total of the fixed and variable expenses (costs to you) to manufacturer or offer your product or service.
- Price is the selling price per unit customers pay for your product or service.
So, the price you set is the cost to the customer. Ideally, it should be higher than the costs you incurred in producing the product.
Think of your cost as the surface of the ocean. You must set your price above the surface to cover costs or you will quickly drown. Of course, there will be times when you decide to set prices at or below cost for a temporary, specific purpose, such as gaining market entrance or clearing inventory.
How the customer perceives the value of the product determines the maximum price customers will pay. This is sometimes described as "the price the market will bear." Perceived value is created by an established reputation, marketing messages, packaging, and sales environments. An obvious and important component of perceived value is the comparison customers and prospects make between you and your competition.
Somewhere between the your cost and "the price the market will bear" is the right price for your product or service - a price that enables you to make a fair profit and seems fair to your customers. Consequently, once you understand your costs and your maximum price, you can make an informed decision about how to price your product or service.
However, while costs are important in setting your prices, don't limit your thinking only to cost-based pricing. Value-based pricing makes you think about your business from the customer's perspective. If the customer doesn't perceive value worth paying for at a price that offers you a fair profit, you need to re-think your game-plan.