Here’s a simple process to price anything.
Pricing a product or a service is more of an art than a science, which is probably why so many businesses have trouble with it. It’s hard to put an equation behind why one business puts a 50% markup on their products, while another one uses a 500% markup. Pricing is not all based on concrete math or itemized inputs, which makes it difficult for a startup to navigate how to price a new product (I’ll be labeling both products and services as ‘products’ for the rest of this piece for simplicity’s sake).
As a startup consultant, I work with a lot of entrepreneurs on pricing their products. I sit down with their growth goals, revenue and expense reports, and scope out their industry to help create a pricing strategy. I’ve seen what startups end up getting right, what trips people up, and what falls short.
Based on my experience, I’ve developed a simple process to help startups price anything. It has worked for me and for the startups I’ve worked with, and I hope that it’ll benefit you too if you’re currently in pricing limbo.
1) Get Your Foundation Right
The foundation of any pricing effort is getting all of the baseline costs accounted for in your pricing. On top of the direct manufacturing costs to make your product, you must also integrate the indirect operating costs to keep the lights on for everything revolving around your product such as: your office rent, employee salaries, marketing budget, etc.
Units Sold —
Once you have a full grasp on all of the costs that are needed to keep your production and business-at-large afloat, you need to project the units you’ll sell accurately. I cannot stress this enough — you need to project the units you’ll sell accurately and realistically.
My favorite example that captures the importance of realistic pricing models is from a scene of the TV show The Office. In Season 5 of The Office Michael Scott starts his own paper company, for which Ryan Howard creates the pricing model for. Ryan has an MBA, so naturally everyone turns to him to crunch the numbers. In this particular episode, Michael, Ryan, and Pam are meeting with the company’s accountant and realize that the company is broke because of Ryan’s pricing model. Although Ryan’s MBA helped create a savvy pricing spreadsheet, it also bestowed Ryan with unrealistic classroom-level expectations of units sold in the startup’s first year of business. Because Ryan’s pricing model relied on economies of scale to turn a profit for the company, the company had absolutely no money since they weren’t selling thousands of reams of paper.
The scene is pretty funny to watch, but it’s also devastatingly real. There are plenty of startup founders that project that they’ll sell thousands of units in their first year and rely their pricing model on it. Please don’t make the same mistake as Ryan.
If your company is projected to sell a thousand reams of paper in its first year, make sure that you’ve already sold 900 reams and know how to easily sell the last 100 reams. If you haven’t already sold this kind of volume and you’re starting from 0, make sure that your pricing doesn’t rely on scale for you to turn a profit and that it’s properly inflated.
Profit Margin —
Once your base price is created, remember to add a profit margin! Whether it’s 1% or 15%, add a little or a lot to create a fund that you can re-invest back into your company’s growth.
Always Know Your Bottom —
When you crunch your numbers above, remember to always be aware of what your bottom / low-end of your pricing is. Maybe this is your price without your profit margin, or with a lower profit margin than your standard margin, but know what this number is and memorize it. This should be the number that no one on your team goes near when it comes to negotiations, discounts, etc. It’s the red flag that signifies that the company is losing money on the sale.
If you know this number and religiously stay away from it, this is the minimum you have to do to have a pricing strategy that works in favor of your business. If you’re really smart, you’ll audit this number every quarter or whenever there’s an influx in spending to make sure that your bottom is still accurate.
2) Price Thermometering
Once you’ve figured out a desired price and bottom for your products, decide on what pricing you want to put out there and test in the market. Take into consideration factors such as competitor pricing, your brand’s value, and target market when deciding on this number.
Testing your pricing and adjusting it according to the ever-elusive customer perception meter is incredibly important. Within the silos of your office, it’s really difficult to understand what pricing your customers will respond to. It is only by trying to sell your product at a specific price that you’ll receive the feedback you need to raise or lower your prices.
Once you’ve figured out a test price, go out and sell it! After selling product at this price, I recommend using customer feedback throughout the experience as data points to guide whether to increase or decrease your pricing. If the majority of your customers (that reflect your target market) did not try to negotiate with you on pricing and had an amazing experience with the product, it’s a reflection that you either set the pricing perfectly, or that you could potentially raise your price.
Alternatively, if many of your customers did try to negotiate with you on pricing and/or had feedback and complaints to improve the product experience, it’s a strong indication that you should lower your pricing, as well as address some of the feedback you received.
A disclaimer about price thermometering —
When you use thermometering to set your price according to response from your market, make sure that the feedback you use is from people within your desired target market. Each industry has several tiers of customer types with different spending levels, so make sure you’re thermometering your pricing according to the right customer (a good practice is to create and follow a target customer check list that lists out all of the characteristics that define your target customer)! The last thing you want to do is to lower your pricing to cater to a segment of customers that you don’t want even want to sell to.
Pricing is a fantastic tool that separates the customers you want to engage with from the customers you don’t wan’t to engage with, so use thermometering wisely!
Price thermometering is simple, and it works. If you’re concerned about confusing your customers by introducing a particular price for your product and then changing it as a result of your findings, market your test price as an “introductory price” or sell it at that price to a select group of shoppers in a closed shopping environment.
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