The Price is Right
The price is right if your Value Improvement Proposition (VIP) compared to your price (your Value/Price ratio) is greater than 1. That is, if the value of your offering exceeds the price, customers will buy. If the value is much greater than the price, they will be happy, possibly even thrilled. Maybe, it will make them say, “WOW!” in a good way. On the other hand, I recently said, “WOW!” when buying a small replacement part for my wife’s car this week. I understand the pricing of aftermarket parts in the automotive industry quite well, but even I was shocked by a multiplier of, maybe, 70x, rather than the expected 7x price/cost ratio. Consider these seven pricing positions:
This is the top end of pricing. It’s where Coach and other highly esteemed brands sit. Their value is measured in prestige and image more than anything else. So many startups say that want to “build a brand” because they believe, or want to believe, that they can charge outrageously high prices that have nothing to do with cost or value.
Value Based Pricing
This is the one many business need to strive to achieve. The value to the customer will, ideally, be much greater than the cost or price of the product or service. Most capital equipment purchases are in this category, as companies strive to convince the customer the purchase will have a lifetime value that is greater than the up front cost, including the time value of money or the cost of capital. Value can include intangible things. For instance, I purchase recycled paper stock for my printer, even though I have to pay a bit more for it. I value something other than the quality of the paper or the cost for this commodity. Realistically, this is more like the top end of the competitive pricing option below.
End User Competitive Pricing
This is a range of values depending on the competitors in your market. There can be the top end competitor and there can be someone that is 30% or more less in price.
Distribution Competitive Pricing
People new to many businesses often forget about the value and profit expected from a distribution chain. Competitive pricing must have a cost that allows everyone in the distribution chain to profit from the amount of work they have to put in. Competitive price to the end user, must account for competitive pricing to the different people that help to get your product or service to the end user. If you sell directly to a customer today, but will need some partners for distribution as you scale up, plan on costs and pricing that will allow it. Don’t set your price too low to begin with, or you won’t have room for others.
Cost Plus Pricing
Companies that are working with the government, or are under regulation by the government, such as utilities, often fall into this category. They are allowed a limited range of markup on the cost of the product or service, and may have to prove their cost to the regulators or contracting agency. I also find many people looking to start a business approach pricing from this perspective, limiting their profit potential and often dooming their business to failure from the start.
Loss Leader Pricing
Many grocery stores and department stores, even car dealerships will use this approach. Just get you into the store to buy that one item that is being sold at a ridiculously low price, even at a loss, and then plan on getting the customer to walk out with other, more profitable items that make up the difference.
Growth Oriented Pricing
This approach is favored by new companies looking to make it big with an IPO in 5 years. Give away the product now to hook people into using the product or service. Then, later, find a way to turn all those subscribers into paying customers. Think of FaceBook and “in app” purchases for a free downloaded application. After all, FREE is just an acronym for Find Revenue Everywhere Else.
Everyone in the business needs to understand your
Value Improvement Proposition
and how it supports your