The Beginner’s Guide to Pricing, Part 1 of 4: What No One Tells You about Cost-Based Pricing

The Beginner’s Guide to Pricing

Part 1: What No One Tells You about Cost-Based Pricing

If you are having problems setting the right prices for your business, don’t worry because you are far from alone in this challenge. You already know that if prices are too expensive, no one will buy your products or services; If prices are too low, your goods or services might be perceived to be of lower quality. So how do you set the right price?

 

Issues with the Most Common Way Businesses Set Prices

The most common way businesses set prices to date is through the cost-led pricing strategy, which takes the costs of the products/services, then calculates price based on the profit margin they want to make.

For example, it costs Wines Inc. $5 to produce one bottle of wine. These costs include the direct cost of grapes, labour and glass bottle, and the indirect costs of the facility and administration. If Wine Inc. wants to make a 63% profit margin, then they will set the price at $11 ($5 x 1.63%), which is a $7 mark-up.

Now, if I tell you that Wine Inc. is really the company that makes Champagne from Champagne, France and that their clientele are very rich celebrities, does $11 make sense? The real issues is that the cost-based strategy does not take into account perceived value!

Why You Should Consider a Value-Pricing Strategy

The value pricing strategy looks at pricing from a different angle by changing focus to the audience, instead of the company. For this strategy to work,  research must be done to understand how the customers perceives the products/services and how they assign value to these products/services.

Using this strategy will:

  1. Help you better communicate the value that a customer gets from the features of your product or services;
    1. For example, a feature of Lululemon yoga pants is that it is made from a sturdy elastic fabric. The value, and what the customer really wants to hear, is that Lululemon yoga pants will make them look fantastic (and skinnier?). In fact, Lululemon just revealed that their new strategy is to sort their pants based on feel: “Relaxed,” “Naked,” “Held-In,” “Hugged,” or “Tight”  (check it out).
  2. Lead to more profitability as you may find that you can increase your prices or save by getting rid of features no one cares about, thus making better margins.

 

In Conclusion, The First Step to Setting the Right Price is….

  1. Understand your business and how you want to position.
  2. Know your audience (i.e. your customer). Ask the question, “Who really is going to buy this and what do they need to see in order to be convinced”.

 

Wendy Ha, CPA, CMA

www.wendyha.com

With over seven years of experience working in small-to-medium sized businesses, Wendy is very knowledgeable in all aspects of accounting and tax. Her vision is to bring a fresh and innovative approach to accounting for small businesses and startups, thus helping them succeed in the ever changing business environment.

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