Growing The Value of Emerging Business    

Experiment To Find Your Product’s Price Flexibility

Pricing is an art and if you don’t get your prices right you’ll have trouble finding either profits or buyers for your products or services. Most experts agree that there are just three basic methods of pricing:

Cost-based: You take the cost of the product and add a fixed percentage of this as a markup or apply a fixed multiplication factor to calculate the final price.

Market-based: You let the market tell you what to charge by monitoring your competitors and matching their pricing.

Value-based: You price your product on the value it delivers to customers rather than on the cost of making it.

Value-based pricing is by far the best of these three pricing methods. It incorporates an understanding of the value your customers receive and focuses your thinking on the benefits you provide. However, of the three basic pricing methods, value-based pricing is the hardest to calculate.

Problems with other methods

Cost-based pricing is severely limiting. It doesn’t take into consideration some of the things consumers value most – quality and service. If your manufacturing or purchasing costs are excessive your selling price will be too high and your products won’t sell. Market-based pricing is dangerous. To gain market share either you or one of your competitors will lower prices, leading to a price cutting spiral that reduces margins and profitability. It’s a lose-lose situation.

Pricing flexibility is critical

Value-based pricing gives you the flexibility you need to grow a business by improving your value proposition. As the value of your product grows, so will your revenues, so it’s worth making an investment to add value to what you sell. There will, of course, be less flexibility when you're selling physical goods, especially commodities. However, if you are selling something like a service or an online product you have a much wider range of possible price levels and a much more flexible pricing structure.

Just how flexible is your pricing?

Look at what you’re selling and think about how you see your business. How good is your product and what level of customer are you selling to? If your product saves a customer a hundred hours of drudgery a year its worth quite a bit, regardless of what it costs. And if you’ve positioned your business above its run-of-the-mill competitors you should be targeting a premium price for everything you sell.

The only way to find out exactly how flexible your pricing can be is to test the product at different price levels in real life situations. This will give you hard data on which you can base your pricing decisions. Let’s use a hypothetical example of a product that costs you $18; you want to test three pricing levels – ‘bargain’ ($28), ‘reasonable’ ($36) and ‘outrageous’ ($49).  How you market test these three levels of pricing is another matter and requires a great deal of thought. But let’s say you get the following results:

1.    At the ‘bargain’ price of $28, 300 units sold for revenues of $8400 and a profit of $3000;

2.    At the ‘reasonable’ price of $36, 280 units sold for revenues of $10,080 and a profit of $5040;

3.    At the ‘outrageous’ price of $49, 250 units sold for revenues of $12,250 and a profit of $7750.

These figures indicate a great deal of pricing flexibility and suggest that further testing at even higher prices could produce an even higher level of profitability.  Only by testing at a range of prices will you know how people will respond to your offering. The aim is to optimize the sales/profitability combination which is just what this kind of testing will do.

If your goal is to acquire new customers you would probably choose the ‘reasonable’ price as the increase from $28 to $36 cost very little in terms of volume. If your customer base is relatively stable you could charge the ‘outrageous’ price and optimize your profits. Only after you have the facts can you choose the price that best suits your overall business objectives.

Source: Ran One

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