Here are four things worth thinking about if you want to approach pricing the right way.
1. Price is how your customer profits.
Many have heard of the economics term “willingness to pay.” It makes sense when studying the efficiency of the economic system, i.e. how to get as much as possible for as many people as possible out of scarce resources. But a much better way to think of it in a startup is the value, purely on the customer’s terms, that the customer expects from the product. The price must be lower than that value by some measure. Your price is the cost for the customer. The customer’s profit is the difference between the price you charge and the benefit they receive. They too want to maximize profits. Thus, a deal they cannot resist is one where their benefit by far exceeds the price they have to pay. A happy customer is a profiting customer.
2. Price is information for the customer.
Price is more than an amount of money changing hands. It is also information. A high price increases the customer’s expectations about the product, your customer service and so on. And a product that is expected by customers to have a high price but is offered at a surprisingly low price is no longer a deal — it is reason for concern. Imagine a Porsche dealer selling new Carreras for $15,000 each. Some might go for it, while many others will wonder what is wrong with those cars and why a new Porsche now costs less than a regular sedan. As a result, the Porsche brand will soon lose value.
3. Price determines cost.
It sounds backwards, but the price is actually determined by the value that your customers expect from the product. They buy your product if you offer them a good deal in value terms (see point one above). Frankly, the customer couldn’t care less about your cost. Your job as an entrepreneur is to profit from the price that customers choose to pay. The only way of doing this is to let the price determine the cost. Choose production process, materials and quantity produced based on the expected price, not the other way around. Cost is the entrepreneur’s primary choice variable.
4. Price is set by the customer.
Indeed, the price is not yours to set but to discover. A price that is too high will lessen sales and profits, but so will a price that is too low. The price needs to be just right. “Right” for whom, you might ask. The answer is that it must be right for the customer. The right price is based on the value the customer expects, and thus the “profit” they make from your product. But they have plenty of products and services to choose from and will choose what gives them most profit — on their own terms. While you get to print whatever dollar amount you wish on the price tag, the simple truth is that the right price is not for you to set and has nothing to do with your cost.
It is a shame that pricing does not get more attention, and it is sad that it never makes it to the top of peoples lists for how to succeed as an entrepreneur. Pricing is core to what makes your business. It is the story you wish to tell and the lens through which the customer sees your business. It should never be an afterthought.