It is not uncommon for companies to set their product pricing using a “cost-plus” approach. However, this is too simplistic and can have a negative impact on profits. A pricing strategy based on the customers’ perception of value and their willingness and ability to pay results in higher profits.
Your approach to pricing has to align with your business goals. What are you trying to achieve? Maximize profits? Gain market share? Two distinctly different goals, each with their own approach to pricing.
Determining the right pricing for a product or service is a complex problem with many facets. This blog post presents a few thoughts on pricing to give you some perspective.
Customer Value, Not Cost-Plus
Of course, you can’t ignore product cost. It establishes a lower limit for the price. Sometimes there is a valid strategic reason for selling a product below cost as a “loss leader”, but most of the time the goal is to make a profit.
A better approach to price setting is based on a sound understanding of customers’ value perception of your product or service. To develop that understanding, start asking your customers questions such as:
- What problem does the product solve?
- How often do they use it?
- When and where?
- Is it critical to their business?
- What substitutes or alternatives do they have available?
- What is the financial impact of using (or not) your product?
Consider Total Cost of Ownership
With a Total Cost of Ownership (TCO) approach you’ll get additional insight into the value of your solution. If your product improves productivity, is more reliable, reduces downtime, requires less setup time, is more energy efficient, or requires less maintenance, just to name a few aspects, you can demand a premium and still have a TCO advantage over a cheaper competitive product that is lacking in these areas.
Armed with insight into customer perceived value and the TCO analysis, you can present a compelling offer to the customer. This beats negotiating about the sticker price without the proper context of the product’s use.
Granted, you need to have the right information and it takes more effort to set prices this way. But, you’ll be able to sell at a higher profit margin than using a cost-plus approach or some arbitrary margin.