ET35- How to Set Pricing for Your Business
Prices are a big deal- here’s how to get it right
In this episode of Questions and Rants, I go over the different pricing decisions business owners face and what it takes to succeed with a high and low price point as well as how framing the value of your solution is the way to charge more than just cost plus pricing or doing it by the amount of hours it takes.
Price isn’t a number- it’s about how much value you are providing compared to the cost of the problem the customer needs to resolve.
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Listen right here:
F.Voice: How do I set my pricing?
Matt: Alright. So, pretty basic question. How do you set your pricing? This is something that a lot of first time entrepreneurs get wrong. They’re not confident in the value their delivering and so, the offset for that is they try and go low on pricing. They try to get in by being the cheapest provider and hoping that people are gonna overlook whatever other deficits they might have and settle for getting the lowest price. The problem with that is it doesn’t leave you any room to grow and it doesn’t leave you any room to over deliver and provide amazing service and get people excited and help you marketing. So, you can go in and you can win some business with the lowest price. But generally, it’s a poor strategy. This is something you see a lot of people do when they spin off from working for somebody, like a housepainter. For some reasons, I always like to use house painting as an example of a business. I don’t know why. I’ve never been a house painter. I don’t know any housepainters. Well, that’s not true. I know some. Anyway, it’s the example that comes to mind. So, the guy for a house painting business and he says “Hey! I’m working like a slave. I’m making my 10 bucks an hour. I see the boss driving around in a Mercedes making all kinds money. I think I could do this. I’m just gonna start my own house painting business and I’m gonna make all the money. I’m gonna have the Mercedes.” So, he splits off and he starts his own house painting business but he’s not really confident because although he has done house painting, he hasn’t done any other part of the business. He doesn’t really know what goes into it. He doesn’t really know what the other costs are. He doesn’t think about insurance or marketing or all the other times that you go out to bid the projects where you don’t get them, the cost involved in that. And so he thinks, “I know my boss would charge $5,000 to do this house painting jobs so I’m gonna charge $3,000 because that’s still more than the 10 bucks an hour that I was making when I was just a working guy.” So, he may got some jobs by bidding low like that but then, the first time that somebody ask you for proof of insurance you’ll go “Oh! I didn’t think about that and I don’t really have enough money to pay for insurance.” Then, you need help so you hire a helper but you’re just paying a man on the table and when that guy fall off a ladder and gets hurt, now you find out he wants you to cover the doctor bills but you weren’t paying him on payroll. You didn’t have worker’s com. All these other things, all these costs that are rolled up in the business, you didn’t realize in. since you were just trying to get by by charging less, you don’t have any extra money to do it right. You don’t have money for marketing. You don’t have money for insurance. You don’t have money for payroll tax and payroll and doing all that. So, the business is really stymied for the beginning and having the lowest price was not a very good long term strategy and the truth is, a lot of people are smart enough to realize that just because a guy comes in with a low bid, it doesn’t mean that’s the one to go with because he doesn’t have enough references. He doesn’t have any insurance. He doesn’t have a lot of experience. He doesn’t seem very professional. They’re gonna be willing to pay a little more to get somebody who knows what they are doing. That’s not a good reference is. He isn’t gonna be around in 6 months or a year if they have problems and need somebody to come back out. So, consumers aren’t generally dumb enough to pay the lowest bid for something unless it’s an identical item. They’re smart enough to kinda price shop and look for the best value not just the lowest price. So, pricing strategy of going low only works in a couple of cases. It works if you’re Wal-Mart because you can get the lowest price from your vendors because you’re buying so much volume and turn around and offer a lower price to other people, to you shoppers, that other people can’t get compete with because they can’t get the same volumes. So, you actually can make money with a low price strategy if you have a system in place to be able to deliver a low price and still be successful. That’s the Wal-Mart model. Or, if you’re Amazon, which is Wal-Mart online in some sense, you can deliver – you can even lose money. You can say “Hey! I’m gonna compete with diapers.com who is a much smaller organization and I’m gonna price my diapers cheap – cheaper than diapers.com and I’m gonna run them into the ground. They aren’t gonna be able to compete. People are gonna come and buy it from me in Amazon instead of buying from diapers.com until diapers.com goes out of business. Then, I’m gonna put my prices back where they should be so I’m making a little money on every sale. But in the meantime, I’ve knocked out some competition.” Amazon could do that because they were much bigger than diapers.com. diapers.com couldn’t get their prices low enough. They couldn’t survive selling in a loss as long as Amazon could because Amazon had all their other business going on while diapers.com was dependent on a much small segment of the market. So, amazon can survive for a while by offering low price – even lower than their cost because of their business model. It’s not that low price can’t be a successful strategy but it has to be a strategy not just “Hey! I’m gonna charge the lowest price because that’s the way for me to get some quick money in pocket and I’m not gonna think about how I can actually have this be a long term viable strategy or how I can deliver something for a lower price.” Which is one other way that a low price can work. If you come up with a new technology that allows you to deliver something for significantly less than any of your competition, you can offer a lower price and still potentially make as much or more in profit as your competition even though you’re charging less because you have some technological advantage that allows you to be more efficient to do it in more time or rather less time, with less man power or whatever the case may be. Somehow, you could deliver something at a lower price and still make as much or more than the competition who’s doing it in an old fashioned way. So, the low price model can work but only in certain situations and there’s lot of situations where it’s not gonna work and you don’t want to be the low price leader. So, when you’re thinking about pricing, don’t just think that the fast way into the market is by charging less than everyone else unless you got a sustainable strategy to be able to make good on that promise and still make plenty of money to be able to grow your business. The opposite end of the low end pricing strategy is the high end pricing strategy where you’re significantly above the market. Again, there’s some cases where that can work. If you’ve got an established brand that people are willing to pay a Premium for and their not as price sensitive if you’re Rolex, if you’re Tiffany’s, if you’re Roll’s Roy’s, people would pay a Premium for what is essentially an equivalent product that they can get from lots of other providers for a lot less. You can buy a perfectly serviceable watch that’s not a Rolex for a lot less than you pay for Rolex. There are reasons people want to pay for Rolex, though, because the brand means something. Image means something. The prestige the comes with it or the perceived prestige, the perceived value that comes with it is not something you can get when you buy a Casio even though basically they are both things that set in your wrist and tell you the time. If you can establish demand and prestige and brand loyalty and brand significance, then you potentially charge a premium price. The other way to be able to charge a premium price because building a brand is something that generally takes a long time and it’s hard to do with the outset, it’s not something a startup can generally build right off the bath. The other way though that you can command premium pricing is by delivering a truly premium product. If you look at the story about Yedi Coolers, if you go to Wal-Mart and buy a cooler from Igloo or one of the other no name brands, you can get a perfectly serviceable cooler for $25 or $50. You put ice in it and it’ll keep you stuff cold or whatever. It’s a cooler. Nobody twice about it until Yedi came along and built a totally indestructible cooler that was nothing like what any of the other coolers where. It was truly a different product. Instead of charging $25 for theirs, they charge $250 or $300 or even more dollars for a cooler. At first pass, you might think “Why would I pay 10 times more for something that is still essentially just a bucket that holds ice?” if you look at it though, how its constructed, what it can do, the strength it offers, the durability and all that kinds of stuff, you could say “Well, that is worth more than buying a cheap cooler that probably that lids are gonna break or it may leak or whatever. It’s only gonna be good for a couple of years of use. I can buy this premium model that’s gonna last longer.” you could possibly justify the cost that way. But there’s also – along with that premium pricing – there is some uniqueness, some prestige, some brand awareness that as some people start to buy it and show it off, there’s a demand that goes with that aside from the premium value, the premium utility value that you get that people are willing to pay more for. So, you can build some prestige around your brand just by the fact that you have a better product but also with a premium pricing. Premium pricing in itself makes it somewhat prestigious if you can get people to pay it. Now, if it doesn’t work, if you take a regular item and you price it high, and nobody can tell the difference, nobody sees the additional value, so nobody buys it. Then, you just got an overpriced product that nobody wants. So, it’s a tricky think to establish without demonstrable additional value that you can show for why you’re trying to claim this premium pricing. That’s on the product side. On the value delivered side, that’s where pricing is a little more flexible. If you can make the argument that you’re delivering a lot of value, then you have a lot more flexibility in pricing. This is for things like training, coaching, memberships or products that deliver some kind of result or solutions. There, it’s more about knowing what the customer perceives as the cost of their problems and they are comparing that cost of the problem with the price of your solution. Depending on how you frame things, you may be able to charge a premium dollar amount or a high dollar amount relative to your cost for the product if you can convince the customer that the solution is still a bargain compared to the cost of their problem. This could be all kinds of different things. You can pay tens of thousands of dollars for coaching on how to grow your business. If you really are struggling with growing your business and you think that turning your million dollar business into a 2 million dollars year of business is something that this particular program can help you achieve, then paying $20,000 dollars for that coaching program may make a lot of sense. That’s $20,000 may be a bargain if you’re actually turned your million dollar business into a 2 million dollar business. Even though you could look at it as “Well, it’s only 2-day seminar. It’s a total of 16 hours. How could 16 hours be worth $20,000?” From that perspective, it seems ridiculously overpriced. But if you can re-frame it, you being the one that’s trying to sell the program, as converting a million dollar business into a 2 million dollar business, then, $20,000 seems like an absolute bargain. I’d pay $20,000 all day long to add a million dollars to my topline, right? That’s a no brainer. So, pricing has a lot to do with the value of the solution that you’re offering against the cost of what the customer is experiencing and whatever the pain is that they are trying to solve that they are considering your product or your service for. That framing of the problem and the solution can help you determine pricing and put the pricing in perspective outside of what people would otherwise look at it as this many hours or this many days or whatever the unit is, whatever they are comparing it to, which is another point. The less comparable something is, the easier it is to have flexibility in your pricing. So, if you’re selling an iPhone Phone Case, there’s a million of them on Amazon starting at $0.99 and going up from there. It’s very easy for people to compare all the different options and decide how much they are willing to spend. If they don’t like what you’re charging or what you’re offering, there’s a million other options. If you’re selling something that is completely unique or very rare, hard to find, not many options, you have a lot more flexibility in your pricing. So, looking at it from a perspective of “How much value am I delivering?”, is there an opportunity for premium pricing or do I have a technological or other advantage where I could offer lower pricing and still have good margins? Those are all kinds of considerations to put into your general pricing scheme. There is no one solid answer. The steps are: first, survey what the competition is offering and see where you fit in that spectrum of competition. Unless you’ve got something that’s brand new to the world, and that’s pretty rare, there’s gonna be a competition. There’s gonna be an existing market for whatever you’re offering. Within that existing market, look at the whole range of solutions and they’ll probably go from very simple, very basic, low cost solutions all the way up to very high end, very expensive premium price solutions. Then, see where you fit in terms of what you’re offering, how unique it is, how valuable it is and what the pain is for that customer, what they are trying to solve or what thing are they looking for to get out of making the purchase from you. See how you can ramp up value as much as possible while maintaining the lowest cost so you have a big spread to see what it cost you to deliver it and what the customer is willing to pay. Then, figure out within that framework what you’re ideal price should be and who your ideal customers are that are gonna pay that price and then focusing on that niche and see what happens. From there, the next step is to test. If you decided that $199 is a good price for what you’re offering, try that. But you may also want to try $149. You may want to try $299. You may even want to try $499 and $99 just to see the range within volume and profit and see where the sweet spot is. You may have though $199 was the sweet spot but you may find that charging $399 even though sales are only half as much, profits are 3 times bigger. So, it doesn’t hurt at all. In fact, it’s a good idea to test your pricing to see if what you thought the best spot is actually the best spot because it’s much better to sell half as many products as 3 times the price than sell more volume at lower profit. That’s just simple math that you can do very easily on a spreadsheet in about 2 minutes to figure out what the best volume is for price and profit. So, this was kind of a long roundabout way of saying there is no right answer for what to charge but there are definitely steps to take to figure out where you should be. Survey the market. Figure out where you fit. Figure out how you can maximize the value that you are offering compared to the competition and minimize the cost of deliver. Then, test from there. Alright, I hope that was helpful. If you got questions or specifics, I’d be happy to hear them and give it my best shot of answering them and then, from there, just have a great rest of your day!