Pricing. It’s incredibly important to the success of every business. Too high, and nobody buys. Too low, and we don’t make enough money. We really need to price it ju-u-ust right.
It’s obvious that price affects revenue, margin and profitability because they all flow directly from what customers pay. But price also affects marketing, sales and our brand.
In fact, pricing supports or undermines just about everything we do in our business.
But very few people – even pricing experts – do it well. Most business owners make critical mistakes that erode price, leave money on the table, and leave them struggling with cash flow issues, often without knowing why.
So let’s do a quick pricing shoulder-check. Here are the five factors that should be considered in your pricing process, along with five key mistakes that are often made.
BTW, I’m putting together a set of videos and a detailed pricing worksheet that will teach you pricing mastery. Click here if you’d like to be notified when they’re ready.
The 5Cs of Perfect Pricing
Pricing properly requires us to look at the 5Cs of Competitors, Customers, Costs, Context and Confidence.
The first three, competitors, customers and costs, are those that are usually taught. Learning them gives you a solid foundation.
Context is seldom taught even though we intuitively understand it and it yields significant results.
And Confidence, as it relates to pricing, is never taught despite its critical importance to many business owners.
Most business owners shouldn’t use their costs to set prices. However, the seeming complexity of pricing leads many business owners to use a simple “cost plus” pricing formula.
They calculate the cost of their product or service and add a percentage. This becomes the price.
The appeal of this approach is undeniable: it’s simple and straight-forward. It feels scientific and, therefore, accurate.
But there are three main issues with this approach:
i. Costs are often calculated incorrectly. In particular, key things are left out. Things like a proper cost for the owner’s salary, debt payments, customer acquisition costs, and allowance for future business expansion.
ii. The percentage that’s added is often too low.
iii. The price that’s calculated becomes the “ceiling” price. In other words, the business will never charge more than this price.
A “cost plus” approach often results in middle of the road pricing or, more common, acts like a low-price strategy. Either way, gross margins and profitability are often squeezed.
We should always look at our competitors’ prices when setting our own prices. They’re valuable reference points and we know our potential customers are looking at them, too.
The mistake we make here is to adopt their prices as our own. We let their prices become the ceiling. We adjust our prices to be equal to theirs or slightly less.
We make one of two assumptions here: first, that our competitors know more about pricing than we do. And, second, that our customers perceive our offerings as equal in value.
We’ve now capped our price in two ways (using costs and competition) and, even worse, we’re likely to adopt the lower of the two when they’re different.
Looking at things from our customer’s point of view (see “Customer Dreams” for a fuller discussion) is not done well, if at all. Which is surprising because they’re the ones that we ask to pay our price.
In fact, PriceWaterhouseCoopers said that “only 13% [of the respondents to their study on pricing] have a deep insight into customer willingness to pay.” And the respondents to their study were full-time pricing experts!
There’s no doubt that trying to understand a customer’s “willingness to pay” or the “economic value” that they receive from your offering is no easy task. But consider this: you already know that their “willingness to pay” is at least equal to your price (or they wouldn’t have bought from you). The chances are good – very good – that it’s higher.
We really must explore what our customers think of the value they receive from us. Otherwise, we’ll leave significant money on the table.
As it pertains to pricing, context is seldom taught but intuitively understood by everyone: one hour of a plumber’s time is worth WAY more to you when a pipe has burst. It’s the same person with the same tools in the same house but we’ll gladly pay a significant premium.
By considering context, we start to see that an offering’s value changes depending on time and place and situation. In fact, there can be a lot of contextual factors which will seem daunting until we realize that each one is a potential opportunity.
The mistake here would be to treat our offering as if one price fits every situation.
Confidence, or self-esteem, is at the heart of pricing for business owners. When we feel confident in ourself, our abilities and our business’s offerings, we expect our customers to value us highly and we feel comfortable setting our prices higher.
When we’re unsure of ourselves, or if we “feel guilty” about setting prices and asking to get paid, this infects our pricing. It creates a feedback loop which puts downward pressure on our prices and, if left unchecked, ultimately reinforces our lack of confidence by creating cash flow pressure.
In general, it’s important to adopt a rigorous pricing process that incorporates external perspectives and data points. This becomes doubly important when confidence is an issue.
Set Your Prices in 4 Steps
Revisit your pricing with the 4 steps below:
- Accurately calculate your costs. Include a full salary for yourself, factor in the future, and add a percentage for profit and the unforeseen.
- Assess your competitors’ prices, but don’t adopt them. Rather, consider how you differ from them and adjust your own prices accordingly.
- Explore the economic value your customer’s receive from your offerings. Use this understanding to move your pricing closer to their willingness to pay.
- Evaluate the effect of context on your offering’s value. Think creatively and search for opportunities where the value you deliver is increased and/or the effect of competition is decreased.
Bonus tip: use a properly calculated “cost plus” approach as your floor price, not your ceiling price.