For many business owners, one of the most daunting tasks is establishing their price. The most common pricing mistake made is using your competitors’ pricing. There are several reasons why this is a bad idea:
- If, as you claim, your offerings are superior to your competitors’ offerings, then their price is irrelevant. It’s not an apples to apples comparison.
- Your competitors typically don’t know any more about quantifying value than you do, which means that it’s likely that they are also using competitors’ pricing as a guide in setting their prices.
- Many business owners don’t realize that their customers are NOT buying their products or services, they’re buying image, innovation and time savings. The degree to which your offerings meet these needs determines the value to customers and, consequently, the price you should be charging. See the What Customers Are Buying post.
If using competitors’ pricing as a guide is a bad idea, what should you use? First, note that value almost always lies in the intangibles.
Products are fairly easy to replicate. It’s much harder to replicate things like friendliness, integrity, dependability, service after the sale, genuine concern for the customer’s welfare. When customers get a sense that you rank high on these qualities, you’ll be able to get premium prices when less effective competitors can’t.
The next thing to consider is whether you’re selling business to consumer (B2C) or business to business (B2B). B2B pricing is almost always negotiated based on the value provided which often differs from customer to customer.
B2C pricing is often standardized for buyers within a given market or market segment which is why B2C prices are often publicized. That doesn’t have to be the case if you add services that meet customers’ desires for image, innovation or time savings.
B2C pricing
If you aren’t adding services to your primary offering and you’re selling B2C, you can use relational pricing to establish your price. Relational pricing is using prices from non-competing businesses to establish your price. Here’s an example (note the prices used are from an old research project and are not representative of today’s pricing; yet they illustrate how relational pricing works):
When I did the research, I could get a sweater for:
- $10 at Walmart
- $12-$13 at Target
- $30-$40 at JCPenney
- $60-$80 at Macy’s
- $120-$140 at Nordstrom
Assume that I’m a chocolatier who intends to produce good quality chocolate at an affordable price. My market is likely to be the same as JCPenney, which means that I can expect to get 3 to 4 times as much as the lowest price chocolate available. Relational pricing is helpful in both identifying your market and establishing your price.
Now, let’s explore what pricing looks like for each: image, innovation and time savings.
Image
The previous example also illustrates how much people are willing to pay for image. Obviously, people who shop at Nordstrom place greater value on image than the other buyers. Walmart customers’ image would be “frugal.”
Innovation
If you’re selling innovation, you can look at the history of other companies’ innovation pricing. The first VCRs were only players, they didn’t record; yet they were priced at $1,200. When recording capabilities were added and more buyers entered the price dropped to $900. The mass market came in when most of the bugs were worked out and the price dropped to $400. Those who didn’t buy until DVDs were coming out paid $100 or less. Price reduction is typical of innovation pricing.
Time savings
Generally, people are will to pay an amount up to their hourly rate of compensation for time savings. Once the price exceeds their hourly compensation, they begin to consider doing the task themselves. If a customer has an asphalt drive which needs periodic resurfacing and their household income is $40,000 a year, they’ll likely pay to have the work done until the price exceeds $20/hour ($40,000/2,000 hours) for each hour they’d expend doing the job, excluding material costs which they incur either way.
Let’s shift gears and move to B2B pricing.
B2B pricing
The key to B2B pricing is to engage the prospect/customer in the calculation of value. Here’s an example from my personal experience. I was pitching a leadership training program to a prospect when he told me that his real problem was employee morale.
Through a series of questions I discovered that his morale problem triggered an absenteeism problem. When I asked him how the work was getting done, he said that people were working overtime and he was using temporary help.
When I asked how much he was spending for overtime and temporary help, he responded “$85,000” and “$40,000” respectively. Then I asked whether he would need the overtime or temporary help if employees were showing up consistently and working to their current level of productivity…no improvement. He said “No.”
I said “So when we solve your morale problem, we’re going to save you $125,000 a year. He agreed. By involving him in the calculation, it was easier for him to see the value and to see how my pricing related to that value.
Typically, I set my price at 50% of the first year’s savings. In this case, I went higher because, in addition to solving the morale problem, I was including;
- Half-day leadership training.
- Six months of coaching for leaders.
- 20-minute session explaining to the staff how their managers’ behaviors were going to change and how they could help their managers make the transition.
In addition to the best solution, as outlined above, I have a lower-priced option available in case they resist the best solution as well as a “throwaway” option, one that’s priced so that they’d never choose it.
When offering a lower-priced option, the key is to present the option, then say “What you’re giving up is…” It forces the prospect to do an objective analysis of what’s important to him.
It’s essential that customers give up something to get a lower price; otherwise, they’re not going to believe your claims about how your offering is superior to others’ offerings.
Takeaways
When your establishing your price, do NOT use competitors’ pricing, it’s irrelevant.
Use relational pricing when pricing B2C offerings. You’re relating your price to:
- Non-competing businesses i.e. in other industries for image.
- The pricing cycles of other innovative offerings.
- The prospect’ current hourly income for time savings.
When pricing B2B offerings, lead the prospect through a calculation of value, then price at or slightly above 50% of the bottom line improvement…remind the prospect that your solution is providing annual improvements to their bottom line.
Value always lies in the intangibles.
Customers must give up something to get a lower price.
If you enjoyed this insight, please share it with friends and colleagues. They’ll appreciate that you’re thinking of them.
Resources
For a complete overview of Greater Profit/Fewer Sales concepts, check out Dale’s books, Pricing for Profit and Generate Greater Profit With Fewer Sales:
Even More Profitable training programs assure that your organization enjoys the benefits of being a Greater Profit/Fewer Sales organization.
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