This article is part of our “Business Startup Guide” – a curated list of our articles that will get you up and running in no time!
When it comes to finding the right price for your product or service, there is no formula and no single correct answer. Even within the same industry, what works for one company won’t necessarily work for the next. Today, a Google search for the term “pricing products” returns 297,000,000 results, almost double the results of a search for the phrase, “writing a business plan”—a business process that does have a formula, and which can be learned.
Pricing products correctly is by comparison, an art. It requires an awareness of the market as it currently exits, the vision and ability to see a market as it could or will exist, and the logic to decide on a figure that will cover costs, send a message and maximize sales.
Because there is no definitive guide to pricing, rather than create my own list, I believe you will get more out of considering what the price you choose will mean for you and your business, and how it will play a key role in terms of attracting your target audience.
Your starting price defines you
In 1986, Pixar Animation Studios was a very different company than the one we know today. It was a hardware company whose main focus was on selling the Pixar Image Computer. In these early days, the partners of the company—Steve Jobs, Alvy Ray Smith, John Lasseter and Ed Catmull—struggled with figuring out how to run the type of business they had just started. For Ed, an early concern was figuring out how much to charge for their machine:
“I was told by the presidents of Sun and Silicon Graphics to start with a high number. If you start high, they said, you can always reduce the price; if you lowball it and then need to raise the price later, you will only upset your customers. So based on the profit margins we wanted, we decided on a price of $122,000 per unit. Big mistake. The Pixar Image Computer quickly gained a reputation for being powerful but too expensive. When we lowered the price later, we discovered that our reputation for being overpriced was all anyone remembered. Regardless of our attempts to correct it, the first impression stuck.” – Ed Catmull, Creativity, Inc.
Ed Catmull acknowledges that for a complex question like pricing, there is no simple answer. Rather, focus on the bigger questions: How will you meet your customers’ expectations? How will you invest in further development of the product? Finding answers to questions that keep the ‘bigger picture’ in mind, should help you figure out the most appropriate price for your product.
Your price positions you in the market
While Ed argues against “start high” pricing advice, Tim Berry, the Founder of Palo Alto Software, believes that pricing too low is the real risk:
“There is no algorithm for pricing. It’s mostly instinct. Covering costs acts as a floor, not a useful indicator. Pricing is your strongest marketing message and most startups should price high, position themselves as premium value with premium price. Oh, and one of the common fallacies around is that startups are supposed to price below the competition. Wrong. Higher is better, by far; and then back that up with value.” – Tim Berry, Founder of Palo Alto Software
Tim and Ed may disagree on low versus high pricing but both recognize that there is more to the question than a “tried and tested process.” According to Tim, you set your pricing based on your situation, the strategy you are pursuing, costs to produce, your competition, the weather, your instinct—basically, whatever is most important to you at the time. And while there is no formula for the right price, there are several mistakes you can avoid making when you get to this stage of planning:
Mistake 1: Thinking it’s best to be the lowest price provider
This approach may work for businesses that sell undifferentiated commodities but strategies that center on being the “lowest price” usually require a lot of initial investment and a very large scale implementation.
Mistake 2: Forgetting that your price is also your “marketing message”
How do you want to be perceived by the outside world? Price too low and chances are the opinion of your product will be low or you will attract an audience that isn’t the one you wanted in the first place. Don’t forget that your pricing sends a message. It says “I believe I’m worth this much” or “this is the amount of value you’re going to get out of this product/service.” In short, it’s your positioning. Be sure to carefully consider what that is before you settle on a price.
Mistake 3: Underestimating your real-life costs
Pricing your products based on your gross margin analysis alone is a bad idea. You also need to consider you overheads —your rent, payroll, marketing costs, utility bills, insurance, hardware and software costs, installation of telephones, new carpets, and whatever other miscellaneous expenses may come up. If you do not take these costs into account when setting prices, you may run out of money
Your price affects your business operations
Beyond the risk of sending the wrong message, pricing your product too low could result in having to compromise your morals and your mission as you fight to remain the company with the lowest prices. Seth Godin refers to this downward spiral as “the tyranny of the lowest price” and provides a perfect example to help you put this notion into perspective:
“To cut the price a dollar on that ebook or ten dollars on that plane ticket (discounts that few, in the absence of comparison, would notice very much) you have to slash the way things are edited, or people are trained or safety is ensured. You have to scrimp on the culture, on how people are treated. You have to be willing to be less caring or more draconian than the other guy.” – Seth Godin, Author & Entrepreneur
The solution? Get known for something other than your price. What is it that your product stands for or that you would like it to imply about your company?
If you have multiple products, your own prices can affect sales
If you’re pricing more than one product, beware! In 2012, the Yale School of Management published a study, which revealed that if two similar products were the same price, the consumer would be much less likely to buy either of the products than if there were minor differences in price. In fact, the study found that when participants were given the option to buy two different brands of gum at the same price, only 46 percent made a purchase. By contrast, when the two packs of gum were priced only a couple of cents apart, 77 percent of the participants bought a pack!
This doesn’t mean you have to price every product differently, just that you may want to keep this in mind when your products are incredibly similar. Done right, you stand to do more than save sales; you could very well increase them.
Consider the bigger picture
Hopefully this list will get you thinking about more than just recouping product costs. As we’ve seen, pricing is essential to branding and to the future of your company so take the time get it right but also to consider the bigger picture. Putting a number on your product doesn’t answer the questions that will steer your business—how will you provide value? How will you develop into the future? How will you adapt to competition?
What do you think? Is there anything you’d add to this list? What else should we consider when it comes to pricing products?