Small Business

The Fine Art of Pricing Your Product


Entrepreneurs face two major dilemmas when deciding what they should ask their customers to pay: How to price and whether to lowball

Pricing (BusinessWeek.com, Winter, 2006) is always tough. To do it right, you have to have a basic indication of what the client is willing to pay, and you've got to have data on the benefits the product will provide. But how do you do it if you're starting from scratch? And how do you decide whether or not to lower a price you've already established when you find yourself in a competitive situation? Those are two of the most common pricing dilemmas facing entrepreneurs. In the examples below, I offer advice on how to handle them.

Pricing Dilemma No. 1: How to Price?

One of my consulting company's clients, Company X, is getting ready to go to market with its first product. This robotic machine improves the lock manufacturing process, relieving a major "pain" (BusinessWeek.com, 4/23/07) for its users—a must for any business. Based on the studies Company X has done with one of its clients, the machine will save the client up to 75% (about $750,000) in one year. The client will need at least four machines. Company X has arbitrarily determined a price point of $140,000 per machine. It cost about $40,000 to make it. At this price, the client's return on investment (ROI) period will be two months. Company X is leaving too much money on the table. It needs to up its price. But how does it justify the selling price?

1) Set client ROI standards. First of all, Company X shouldn't say ROI is two months. That's too short a period of time, and the client will be disappointed if the ROI ends up taking longer. X should double or triple the expected ROI period, as it is making three assumptions:

The client will use the machine in an optimal fashion immediately, which it likely won't.

The client will do the training/read the manual—again, this is unlikely.

The client won't have any staff turnover—it's pretty likely there will be turnover. Better to under-promise, over-deliver.

When launching a new product, triple the anticipated ROI period if you expect it to be three months or less. Double it if you expect it to be four months or more. After a few client installations, you'll have more accurate ROI data and can set expectations more appropriately.

2) Set pricing standards. I'd like to see a higher profit margin for Company X, because the estimated cost of building the machine likely doesn't involve all the true costs of it, or cost of goods sold—such as the cost of the salesperson and office overhead. I like to price at five times the total cost of creation, or more on "hard" products. For "soft" products, such as information or training, I like to set the price at 10 times or more.

For Company X, instead of its arbitrary $140,000 price, I'd prefer a price of $200,000-plus (that's five times the total cost of creation), with a limited offer of a lower price to get people to make a decision faster. Also, X could offer a "bundle" price—to buy one unit, it's $180,000, while two units result in a 5% discount, and three to five units means a 10% discount. Also, everyone does love to price below an even number. So Company X could try $179,995 instead.

When you don't have a basic indication of what the client is willing to pay or data on the product's benefits, such as with a new product launch, set the price higher and offer a "special introductory price" that is 10% off the "real" price.

Pricing Dilemma No. 2: To Lowball or Not to Lowball?

Let's say you've nailed your ROI and proper pricing, but you're in a competitive situation. What do you do? Consider this scenario: Your company is in a heated selling bake-off. Your competition's pricing is similar, but you have healthier profit margins. You know you can lowball and offer a price way under the competition. Should you do it? That depends. Here's how to determine what to do.

1) Be aware of what differentiates your company from its competition. If you have a tangible differentiator, don't lower your price. One of my former companies sold services head-to-head against the Big Six accounting firms. We were competing to provide expertise in converting corporate information systems to Microsoft(MSFT) Windows. I had four years of Windows engineering expertise—I was even on the Windows team at Microsoft. My team was equally strong. The Big Six had six months of Windows experience. No need to lowball—we had the expertise advantage.

When your company is equal to the competition, you shouldn't lower your price. When I started a staffing company and was competing with a large job shop to hire highly skilled freelance programmers, I did lowball. The programmers were the decision makers. They didn't care who paid their paychecks, they wanted only to keep working at Microsoft. In this case I paid the contractors a piece of my profit—more than the large job shop would—because I had no differentiator.

2) Know the right price point. Many managers in Corporate America have signing authority of $2,500 or less. So price your product/service at a level they can approve. Then upsell them later. Getting your foot in the door is key. I started out selling a product for $1,995. Within a few months I upped it to $9,995 for a work group license, then $24,995 for a departmental license, then into a healthy six digits for a site license. Again, when you're launching a product, you have to test the waters.

3) Position yourself according to your pricing. Make it clear if you're a specialist or a commodity provider. A specialist can charge more, but a commodity provider can learn to differentiate on service. Consider Federal Express(FDX) vs. DHL. Service levels can boost the price for a similar product. If you go the specialist route and charge high-end prices, your image (Web site, collateral, all customer-facing activities) must reflect this.

How has your business solved a pricing dilemma? Share your solution in the comments box below.


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