The Price is Right! … Right?
Pricing Your Products and Services
Published on January 29, 2020
Have you ever called an Uber at the airport, only to realize that the ten-minute ride would be $50? You were probably wondering: do people actually pay that price?
For a company to make money, it is important to generate sufficient revenue to both cover expenses and ultimately earn a profit. On the other hand, companies that charge too much will find that customers view them as an overpriced vendor. Many a business owner wonders if s/he is leaving money on the table.
There are different ways to price, but all are subject to cost, supply, and demand.
Use cost as your baseline. Look at the cost of staff and any other inputs needed to produce a widget. Next, determine the cost of overhead. Look at how many widgets you can sell and determine the amount of contribution (money left over after paying for components) to cover overhead. If you have nothing left, you are charging too little. If you have a lot left. You’ll make money, but leave yourself exposed to competitors that see the profit potential. From there, consider supply and demand.
During our consultations at Imperial Advisory, we are often asked about how to determine a price. While there are a host of factors that go into any complex pricing decision — as well as market-specific factors — what follows is a guideline we find to be informative.
1. You can fix your price high.
This works particularly well for a service or product that involves a high level of service. Your high price is justified by the level of service you bring to the table. Whether it is a unique type of service (e.g. complex legal advice), or a high level of service provided for a commodity (Your neighborhood promotional product firms will sell you the same promotional items that you can get cheaper online. But “online” won’t communicate with you. “Online” won’t tell you to go to vendor x since they are close and can do a rush order without a rush charge.), people looking for expertise or a premium experience will pay the premium price. Students preparing to take the SATS could simply buy a practice book, but costly SAT tutors exist anyway. A book can’t talk you through a problem or answer your specific questions. A book can’t offer firsthand or personalized advice for individual test-taking. That’s a unique and valuable offering. The risk of method #1 is that you won’t have your pipeline full. Some people will price shop. Others will say “that service is something I don’t need or want.”
2. You can set your price low.
This allows you to capture all the demand, but you are probably leaving money on the table. If you are satisfied being a commodity and making it up on volume, this works. Think of a restaurant. If they have a long wait to get a table, they could probably raise prices. But this would push some people out of the market which would shrink the venue’s customer universe. Keeping prices low and affordable would decrease the profit per plate but potentially increase the restaurant’s final profit.
3. Demand-based dynamic pricing.
You can also adjust prices based on if you think demand will be high or low or just put it out to bid. Google does this with Ads. You bid whatever you are willing to pay. If no one will pay more you get the slot. If someone pays more you don’t get the slot. Google never feels they are leaving money on the table. This works well for companies making sales that have fixed costs independent of sales quantity and a diverse consumer base deriving different amounts of value from the product. The risk for vendors employing the Google strategy is that their advertising clients have no idea what price to expect. Some clients will seek out a more reliable process, one where they know a definite cost and if their ad will run. This, in turn, reduces demand which will reduce the potential price. Another company that famously tried this was Uber. They had a concept called surge pricing; as demand went up, so did the price. From personal experience, I can say that we sometimes take regular cabs since the Uber price gets too high. Another example of dynamic pricing includes tickets for flights, hotels, and entertainment. These vendors may also give out cheap seats at the last minute. They’re targeting different customers than the ones that bought in advance at full price. If you only want cheap stuff you wait and risk not getting a flight. If you have an important meeting or family event, you plan ahead and pay up. Businesses that only produce a limited supply can use this strategy to extract maximum value from their customer base — although those “maximums” differ from customer to customer. And because the cost of, say, producing a concert will cost the venue the same amount regardless of ticket sales, accepting a slightly lower-than-average maximum value from a customer is better than none at all.