How much? It’s an inevitable question that nearly everyone asks during the buying process for most items. Sure, there are exceptions. You might not ask how much the cup of coffee is because it’s posted on the wall or you know the approximate price and any small deviation doesn’t matter. Or you might be in that small class of people where money is absolutely no object. But for most of us, when making a purchase decision we ultimately have to ask: “How much?”
Before I go further, here’s a brief disclaimer. There have been numerous books written on pricing strategy and theory. There are at least a couple on my bookshelf. I won’t pretend to cover this topic in depth in one page but I do want to give you something to think about.
Now, when we get the answer to “How much?”, we then have to make a decision between our perceived value and the price that was just given to us. The topic I want to explore today is how that price was determined.
In some cases, the market for a given good or service is relatively efficient. Sellers know they are competing against each other and that they have little choice but to sell at the market price (think commodities). On the other hand, there are unique goods and services where there are few or no substitutes. And, of course, there is a continuum in the middle where there are varying degrees of real and perceived differentiation.
So, other than for commodities where sellers are pure price takers, how do they arrive at a price for their product or service? This is where pricing strategy is both art and science. Usually one is trying to set a price to maximize profitability, market share, or revenue over a particular time period (and the three are not necessarily the same). This involves determining how many dollars can be extracted from a particular customer set and that further involves understanding their real and perceived value. One customer might have a very different perceived value than another for the exact same product or service and it’s critical that you understand that within your target market.
Let’s take a simple example of a plumber who has a shop equidistant between a modest working-class neighborhood and a very well to do neighborhood filled with luxury homes and automobiles. The cost of rolling a truck to a home in each neighborhood to fix a leaky faucet is the same but the perceived value may be very different. In the case of the working-class neighborhood, an individual is more likely to fix the problem themselves or ask a neighbor who is handy to help. The $200, for example, to have a licensed plumber come out may stretch the family budget or cause them to forego something that they consider more important. While in the high-end neighborhood, $200 may seem like a relative bargain. A highly paid individual will likely not think twice about spending the money and may not even ask about rates when they call the shop. From the plumber’s perspective, the cost of fixing each is the same but for every 100 leaky faucets they are going to get many more truck rolls to the high-end neighborhood than the more modest one because the perceived value differs.
Note that my focus has been on the value. Yes, it’s critical that one covers their cost plus a reasonable profit but cost should not be the sole determinant of pricing. If cost is your only consideration, you are just looking at one piece of the pricing puzzle. It’s much more important to consider both the real and perceived value you deliver through your product or service rather than just the cost especially when it is unique or you can differentiate it from others in the minds of the consumer.
So, the next time someone asks, “How much?” give some careful consideration as to how you arrived at the answer!
If your business could benefit from fractional CFO services, I would welcome the chance to speak with you. Please give me a call at (314) 863-6637 or send an email to [email protected]
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