Congratulations! You have built this awesome company. You have products and services, and now you want to price them. The pros discuss the constructs of cost-based pricing and value-based pricing: “Value-based pricing is the setting of a product or service’s price based on the benefits it provides to consumers. By contrast, cost-plus pricing is based on the amount of money it takes to produce the product”. Deciding the model to adopt for the optimal value creation, in your startup, is the next level as you fix the launch date.
You possibly have some marketing guys to assist. Marketing is a great profession. The bests in the field understand how to present their product offerings to customers to get them to open their wallets. Irrespective of the quality of the product or service, a very poor marketing campaign could be very disastrous. This field is full of psychology. They focus on mastering the behavior of man under his limited scarce resources. He must make choices and bring that concept of opportunity cost in action; and making sure your product wins in this choice makes a star marketer.
The Pricing Options
The best marketing strategy begins with pricing. Pricing is such a very huge aspect of microeconomics and the all important topic of demand and supply. Depending on products and markets, a manufacturer could go with value-based pricing or cost-based pricing. In most cases, I prefer the former as the seller could win big provided he understands the potential customers very well.
Under value-basing pricing, you are examining the ability of the customer to pay, focusing on the value you are creating for the customer. So, it opens the door to super high profits or possible losses just to keep your market share. For instance, you want to introduce a new brand in a market and your feasibility studies show that your customers cannot pay more than a certain amount that will enable you to break even. Yet, you move ahead because presence in that market provides future prospects for growth and profitability.
Pharmaceutical companies do that a lot when they are moving into developing economies. The prices they ask for their products are aligned with the power of the patients to pay than what the products cost them. Through that, they increase market share as more patients buy their products. This implies that a drug that sells $200 in Florida could be sold for $50 in Botswana by the same company. Simply, it is using the purchasing power of the market to drive the marketing dynamics.
The other one- cost based pricing- looks at setting price that will give you a certain profit level. You look at your fixed and variable costs and based on those arrive on the price of the product. This method may not be ideal in most cases and I think it is a weaker strategy. Marketing is a behavioral science and having rigidity could hurt you in the market. It is better to know your break even point and possibly ascertain if you can take advantage of the purchasing power of your customers.
In a commodity market where differentiation is very limited, cost-based pricing could win. Irrespective of your pricing technique, it is vital you know your production cost before you map how to market your products. Some markets command great mark-ups while some do not. If your product is elastic, you must approach the market, understanding the behavior of price to your customers.
Similarly, for high entry barrier markets like pharmaceuticals, cost-based pricing will never win. The products are so important that consumers rarely have choices than to buy within the industry. That is why the Big Pharma could make profits in excess of 2000%.
The Pricing Psychology
First, you need to examine how you actually get to buy things. Marketers work our brain. Look at it this way with basic examples. You visit a grocery store and see a big markdown in price; say 60% off. The reality is that there may not be a markdown. The seller simply understands that you will think of a bargain when you see big markdowns and then open your wallets.
In short the propensity to pay $20 for a trouser after the original price was marked down by 80% is higher than paying $18 for a similar trouser without a markdown. The latter does not communicate winning in our brain, while the former gives a feeling of success and win. But in reality, you lost, financially, in the former by $2. Have you ever wondered why a grocer is stocking a product for the first time and immediately marking it down by 30%? They also try to give a relative time stamped pricing like “was $200, now $50” or they yanked a product very high, mark it down immediately and use that old price to give an impression that price was cut.
That brings another point where some airlines will tell you that bags could be transported free and then charge high ticket fees to cover that cost of bag. Others will charge for bags, but their ticket fees are lower. Which one is better? It depends if you carry checked bags when you travel. The one that charges for bags could be more efficient as the price is not shared by all customers. So if you carry checked bag, you pay for it; otherwise, no worries. The other one distributes and subsidies the costs of the bags for those that carry bags and then make ticket fees more expensive for those that don’t. However, you may be stuck with the theme that your bags were not paid in one without realizing that your ticket fee was higher.
Psychology of pricing is in everything we do. Government, especially in U.S., wants our taxes to be withheld and then at the end of the year, they send us tax refunds. Though this is really a very inefficient system to us, the payers, since the government is not paying interest on the money we have “loaned” it, we tend to think we made a gain. Simply, any time you get a tax refund (i.e. if you overpaid your taxes, not for social benefits), it means you have not invested your money very well. You gave government free loan accumulated over one year; that money might have yielded some interests if invested. But what can you do? Nothing, because it is government and in most cases, it can be designed to look like government just did you a great deal while in reality they used your money for free and not paying any interest.
Pricing is very important and making customers to feel like winners is very important. If you know how to do that, you will have a great product launch. That is why understanding your customer matters. If you do not understand them, you will be leaving money on the table. If your business is selling digital products, the best strategy is value-based pricing since cost-based model does not make a lot of sense: in a perfect market, the marginal cost of a digital product, under most scenarios, is zero. I am confident you will not give out the product for free, unless your business model is freemium, since theoretically the price should be zero.
A startup must invest efforts to understand its customers towards having the optimal pricing strategy. You cannot afford to leave money on the table by pricing timidly. The ability to ascertain value created by your company is the foundation that will help you model how much customers will pay while considering many other factors like growth, product penetration and competition. As always, it is easier to reduce price than to raise it, in a digital product, especially when you do not have a highly differentiated product. This means you may begin high, and after checking the market dynamics, you will adjust accordingly. You must make pricing a science.