Getting customers to pay for what you are offering is one of the most problematic aspects of building up a new business. It’s all about setting your product or service at a price where both you and the customer are winning.
Not an easy task.
Price setting is like something out of that fairy tale about Goldilocks and The Three Bears. Not too hot, not too cold, but just right.
If you set your pricing too low (too cold!!) then you will be unable to generate solid revenue to get the business up and running and attract investors. If you set pricing too high (too hot!!), then you won’t be able to attract customers or compete in the market.
So, how do you find the sweet spot? While many believe that price setting is equal parts experimentation and educated guessing, there is a more logical way to approach the task.
Alex Glassy is the creator of StratPad, planning software and has a long career of working with business startups, including five of his own. Alex is a highly regarded thinker in the world of startups and coaches around the globe. His 5Cs for Perfect Pricing approach is one of the soundest methodologies we know for developing a pricing strategy.
The 5Cs of Perfect Pricing
Before starting, it’s important to consider that pricing will affect everything you do in the business. It’s not only about revenue and profitability, but it also affects marketing, sales and the brand. So, it’s worth thinking hard about pricing before getting started.
The perceived 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. Often costs are left out, like 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.
TIP: Use a properly calculated ‘cost plus’ approach as your floor price, not your ceiling price.
Competitors’ prices are 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 orslightly 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 ourofferings 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.
Tip: Assess your competitors’ prices, but don’t adopt them. Rather, consider how you differ from them and adjust your own prices accordingly.
Looking at things from our customer’s point of view is often overlooked. This is surprising because it is customers who are the ones that we ask to pay our price.
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.
Tip: Explore the economic value your customer’s receive from your offerings. Use this understanding to move your pricing closer to their willingness to pay.
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, place and situation. In fact, there can be a lot of contextual factors that will seem daunting until we realise that each one is a potential opportunity.
The mistake here would be to treat our offering as if one price fits every situation.
Tip: 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.
When we feel confident, we are more willing to expect our customers to value us. We, therefore, feel comfortable setting prices higher.
When we’re unsure, we feel guilty about setting prices and asking to get paid, which in turn infects our pricing with doubt. 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.
Tip: Confidence is at the heart of pricing for business owners.It’s important to adopt a rigorous pricing process that incorporates external perspectives and data points.
You may want to explore free product offers or freemium models to attract interest and turn that interest into customers. But for many startups, giveaways aren’t a suitable way to introduce their product or service.
And don’t forget, a new player or a disrupter that enters the market may force you to look at everything from scratch again. So, whether you are giving it away for free to charging a premium, the implications of your pricing strategy are immense.