Have you ever met someone in the marketplace who has an awesome service, product, or idea and then you find out their price point and are instantly turned off?
Is their price point high because they have a proven track record of success, or do they have a truly unique approach to solving the problem. Or does it come off as arbitrary?
Please don’t take this the wrong way — in every circle of friends there is that guy/gal that everyone just puts up with… and if you are thinking “I don’t know that guy” it’s probably you (Dane Cook calls this person Bryan). Same thing applies here, if this hasn’t happened to you… Well you watched the Dane Cook skit 🙂
Let’s stop doing this! There is a better way to price prior to taking the product or service to market.
Pricing should be based on something
Micro-economics teaches us that supply and demand drive price. For example, if I am a baker who is just getting started, I have no demand but a high supply. Ultimately that means my price point should be low to sell off my supply and increase awareness about my service.
Once my awareness (demand) increases I have to raise prices because I am now a more limited supply. Make sense? Let’s look at this graph as I find seeing the curve makes this easier to understand.
Based on the image above, if I am a new baker on the market, I would want my price to be low on the red line till I start generating higher demand for my services. If I enter the market at a high dollar, then everyone will wonder why my pricing is so high and I don’t have enough credentials to prove I am worth that price point. What would happen? You guessed it, no clients, no business. However, the opposite is also true if we don’t take something else into consideration when establishing our pricing.
Pricing should also be based cost
If we know it takes 3 hours to bake a raspberry filled chocolate layered cake, with decorations and all, we then need to determine cost of our time, cost of materials before we determine price point.
As a business owner, the baker maybe doesn’t pay him/herself for the first 2 years. So the hourly rate is less important as the hard costs. Lets assume the hard cost to make the layered cake is $25 for all the supplies. Well we need to at lease break even on that cake, ideally we would like some profit margin back to the business for reinvestment of more supplies.
This usually is 20 to 30 cents on every dollar or 20%-30% profit margin. That would make my brake even retail price point $31.25 for that layer chocolate cake. Make sense?
What is Margin?
Margin is the difference between the cost of goods sold and the net sales price for the purpose of contingencies or special situations. It is important to build in margin to every pricing decision. These are what make or break a new company at the end of the day.
If we haven’t built in any margin, when a cake goes wrong then we now have extreme out-of-pocket costs that can’t be recuperated in future sales.
Pricing is based on 4 things
So whats the 4th thing?
For those in the services sector, our pricing needs to be based on our skill level as well. For example, if I am a new welder who just got my degree from Guilford College for welding, I can’t charge the same rate as the welder I just apprenticed under for 4 years. He is a master welder and really knows his stuff…even though I learned from him, I don’t have his years of experience to back up my rates.
I then need to come into the marketplace at a lower price point that is fair to my time and the welding trade, but is also fair to my actual skill level. A professional welder may be able to ask $100-$150 per hour where as I may only be able to ask $50-$65 per hour till I build up my welding portfolio. Make sense?
Why is pricing important to small business?
With out the right pricing structure in place we can shoot ourselves in the foot and fast for closing our doors. If we charge too much out the gate we wont have any clients, if we charge to little we will be inundated and loosing our shirts to keep the lights on.
Pricing structure is a vital component to building a stable foundation within your organization. The trick, like with most things in business, is making is scalable. Just because the baker charged $25 to cover hard costs at first, once she has 20 people calling regularly with more knocking on her door, she can’t keep charging $25 and keep the lights on, she has to scale her pricing. The welder I mentioned, 2-5 years into working in the trade he can start scaling his rate up too, and after 25 years he could make just as much as the mentor did before him.
Building a business that is sustainable means building in scalable pricing models and scalable structure to systems and operations. It is the only way businesses can grow and keep the lights on long term.
As always, thanks for reading! Please feel free to provide your thoughts on the topic below.