Establishing a pricing strategy for your business is one of the most important and challenging things you will do as a business owner. The wrong price can make or break a business, impacting profit margins and cash flow among other things. We will take a look at three different strategies in this post as well as the one thing that holds business owners back from pricing for value, fear.
What Would You Attempt to do if You Knew You Would Not Fail?
Fear is a strong emotion that can paralyze us. When it comes to establishing prices for our products and services, fear often raises its ugly head. What if no one buys from me? The competition has so much more experience than I do, how will I justify that price? The best way to overcome your fear is to do solid research up front. You have a business idea. Market research confirms that there is a market for your idea. You know what problems you solve and who you solve them for. These are your value propositions. Note the use of the word ‘value’. By solving someone’s problem you bring them value. They will pay you for the value you bring, these are your Ideal Clients.
F-E-A-R has two meanings: forget everything and run or face everything and rise. The choice is yours.
Cost Plus Pricing as a Strategy
The goal of cost-plus pricing is to ensure profitability. It is the simplest way to determine price. Simply put, you will determine your cost of production and add a margin that you think the market will bear. It provides full coverage of your costs and provides a reliable rate of return. This assumes that the cost per item or user has been added up correctly.
The formula is: cost of production + desired profit = price.
There are a few downsides to using this method of pricing:
- It has little to do with what your customer is willing to pay
- It ignores competitor strategies
- The guarantee of a target rate of return provides little incentive for looking at cost-cutting measures and fosters laziness
- As the market and customer continues to change, profit margins may decline
Competitive Pricing as a Strategy
Competitive pricing looks at the prices set by other businesses in your market and adds or subtracts based on where you think your product fits in. When there are a lot of competitors there’s more data making this method fairly accurate.
Simply, you take all of your competitors and line them up from the most premium brand to the bargain brand. Then decide where on the spectrum you fit, slot yourself in there and set your price accordingly.
Some of the downsides of this pricing strategy include:
- It assumes that your competition actually know what they are doing when it comes to setting price
- Setting your price below your competitors can lead to a perceived lesser value by customers
- It ignores what customers are willing to pay, eating away at potential profits
- Competitor based pricing can lead to a ‘set it and forget it’ mentality when pricing is a process that requires data and attention
One of my best friends suffers from a severe case of fibromyalgia. For the past 10 years her condition has been so debilitating she has been on long-term disability, unable to work or do most of the activities she enjoyed throughout her life. She suffers from chronic pain.
I was speaking with a client earlier this month who offers a holistic healing modality that can seriously reduce, and sometimes eliminate, chronic pain in just a few sessions. She has been operating her business for about 5 months. She said, “I think I should drop my price by $10 per session to get more clients”. At $90 per session, she was below her competition by $5. A session typically lasts between an hour and an hour-and-a-half. I asked her about the clients she has and how they were faring following having worked with her. One had gone for 6 weeks without pain after being in constant pain for years. The time without pain increased following each session she had. My question:
What is that worth?
What is it worth?
How valuable is it to go from constant pain to no pain?
This is what value-based pricing is all about. It takes more work, more research, than the other strategies we have talked about but, if done correctly, value-based pricing helps you generate the most profit.
The Pros of Pricing for Value
It starts with the customer and looks at real “willingness to pay” data. When you understand your value propositions and the customer segments served by them, you can do research. Ask the people who you think will benefit from buying your products or services questions such as
What is the value of (saving time, reduced pain, better relationships, time with your family, convenience…)?
By going through the process you will not only determine a more accurate price for your product, but you will benefit your business in so many other ways. It will help you discover what customers are really looking for in your solution. Products and features driven by consumer demand raise the perceived value and result in a higher price.
While you are interviewing potential customers, you are demonstrating to them the importance you place on delivering value. This results in more loyal clients who develop a bond with your business, trusting you provide the value you claim you are in your price. They know you create higher quality products and provide outstanding customer service.
The Cons of Pricing for Value
Value-based pricing is a process that requires consistent work, not the ”set it and forget it’ mentality of other pricing strategies. The strategy takes both time and resources, but the increase in profitability is worth it.
Setting Your Value-Based Price in 4 Steps
Do Your Research on Your Product or Service
This step involves looking at the different elements of your business, what it takes to get them done, and the value each element brings to the customer.
For example, you might offer sales and marketing automation services that might include training videos, sales and marketing automation software, setup of the software, and implementation of the software.
- Do you offer these elements separately or are they all included in the final product? You might choose to offer different packages such as a ‘do it yourself’ training package, a ‘done with you’ package and a ‘done for you’ package.
- For each package, what materials and other costs might be included in the price?
- What is the typical timeline to deliver each element?
- What are you offering that your competitors are not?
Identify and Analyze Your Ideal Clients
The better you understand who your potential client is, the better you will understand what you offer them in terms of value. In order to do this develop Ideal Client profiles or Buyer Personas. The key is to identify the most common customer groups in order to understand what they are looking for in terms of a solution. In doing this you want to establish what elements of the product or service the buyer persona values the most and the realistic price range they are willing to pay.
The best way to find answers to these questions is to conduct a survey of your target market using an online survey site such as SurveyMonkey or conduct one-on-one interviews. In terms of value, ask them which elements they feel add quality to the product or service. In terms of price, ask them directly what sort of price they would be willing to pay. If you can, find out at what price they would consider buying and at what price they would definitely not buy. Finally, ask how they would prefer to pay. Using our sales and marketing automation service example, this might include up front, monthly, in installments, etc.
Evaluate All of Your Price Data
At this point, you should have data on what you used to charge for the product or service, what your competitors charge for their similar product or service and what customers tell you they are willing to pay for your product or service.
By creating a spreadsheet that includes all of the data and creating charts, you should be able to see what types of patterns emerge. Is there a point where customer interest drops? Have your personas identified different elements they are interested in, suggesting you offer slightly different products to different buyer groups?
Test Your Price and Adjust Accordingly
As customers’ needs change, so will the value they attach to different elements in your product or service line. At the same time, your experience and expertise are going to grow as time goes by. As you implement your new pricing, it is important to keep an eye on how it affects your sales.
If you are a new business, it might take time for sales to ramp up. If they don’t, you should consider conducting more surveys to ensure you have the right value proposition and adjusting it. You might also try offering a discount to see if sales pick up.
If you are consistently busy and saying no to new clients or having a long lead time before you can take on a new client, you may want to consider increasing your price.
Regardless, pricing for value is an ongoing process of market testing and customer research so that you always know what customers are saying about the value of what you offer.
At the end of the day, your pricing strategy must leave your business with a return on investment (ROI) or profit. Your customer must also feel that they are obtaining a return on investment. This is the difference between the price they pay and the value they perceive they are getting from your product or service as a solution. If you can find the sweet spot between your ROI and theirs you will have a winning formula for a successful business.