Pricing is a doubt elimination process
For years, pricing has been this ominous beast that businesses wait to tame until they can afford a “pricing team” or “pricing consultants.” We think that’s poppycock. Pricing is the last thing that should be locked up in an ivory tower. Instead, look at your pricing strategy as a way to eliminate as much doubt as possible. The metaphor we like to use is a dartboard. In the game of darts you’re not always trying to get a bullseye. Instead, sometimes you’re focused on specific panels or points. Similarly, your pricing strategy is working to find the best point on the board, out of all the other points, to sustain your business and capture as much cash from the table amongst your target customers.
For most, the traditional pricing strategy involves purely focusing on everything that supports the dartboard: marketing, sales, product development, finance, etc. When it comes time to pick a point on the board, the management team gets in a room, agonizes about what the best point should be, and more often than not, simply tosses the dart and picks the point where it lands. In other words, a lot of smart people are simply just guessing, because they have no data to tell them where to go on the board. What’s surprising is that this strategy does work, because with a halfway decent product, some good marketing, and a sales strategy someone out there will buy your product and, therefore, validate that price. Of course, this isn’t the best strategy for maximizing revenue or boosting profit.
As such, your pricing strategy must eliminate as much doubt as possible. Think about it as a way to eliminate sections of the dartboard, focusing in on the right region for your dart to land. When you go to business school they teach you there are three tactics to paring the dartboard down: focusing on the customer, competitors, and costs.
Focusing on costs: cost-plus pricing
Cost based pricing is fairly self explanatory. You do everything you can to calculate every cost you have for producing a product or a service, and then you assign a margin on top of those costs. We’ll go through cost-plus pricing more extensively in another post, but utilizing your cost data, you at least know what region of the dartboard you need to be on to sustain your business. Of course, you’re still guessing on the margin you’re putting on top of the costs, but more data is better than less in the pricing process.
Cost tactics are typically used in the retail space, because you have set physical costs. Yet, as we explained in a previous pricing strategy post, you’ll never figure out 100% of the costs within your business nor the costs to your customer. Additionally, products in the software and SaaS space have negligible costs compared to the value provided to customers
Focusing on competitors: competitor based pricing
Once again, this pricing tactic is fairly self explanatory. You stack all of your competitors on a totem pole and decide where on the pole you sit, setting your prices accordingly. For most businesses, competitor based pricing is a step up from cost-plus pricing, because there are more external data indicators to guide the pricing process.
You’re still guessing though with competitor based pricing, because most products are not completely congruent. Comparing a specific vacuum cleaner to a dozen different vendors gives you a fairly accurate view of the market, but comparing automated testing software muddies the waters, because feature lists are not the same. Plus, measuring brand power or how much a brand is worth is exceptionally difficult when comparing products.
Focusing on customer: value-based pricing
The coup de grâce of pricing focuses directly on the willingness to pay of the customer. Through different value models you utilize survey input, data crunching, and the like to determine what target customers are willing to put down for your product. Experts and intuition say that this is the best way to price, because you’re relying on customer input. Of course, getting to the customer’s willingness to pay is not the easiest thing to do, which is why most people go down river to competitor, cost, or guess based pricing.
Keep in mind too, this isn’t a silver bullet that spits out one single price for you to throw on your pricing page. Most value models spit out a range that still forces you to make a decision. Yes, the range may be “$100 - $130” or “$10 - $15”, which, of course, makes the decision much easier.