I just read a Blog from the Business Development Bank of Canada called 7 Steps to Setting the Right Price for Your Products or Services.
The Blog makes some good points. I have 2 comments on it, though.
Firstly, the Blog has the overall wrong focus. It is inward not outward. This is common.
What do I mean? In this BDC Blog the first two steps are:
- Calculate your direct costs;
- Calculate your Cost of Goods Sold.
Those steps are important, but not yet.
Your internal costs should not dictate your prices.
Yes, you read that right.
Why? No one cares.
Think about it. When you shop, do you care if that store is either:
- Losing money on that thing you just bought? or,
- Making a killer profit on the sale?
No difference, right? You are looking at one thing only – value for money.
And, that is subjective. It varies from person to person. Place to place. Time to time.
This leads me to the first thing you must look at in pricing….
What Do People Value in Looking at Your Products?
Why do they shop with you? Is it unique? What makes it unique?
Let us look at two simple examples –
First, things have subjective value. There are a group of consumers who value the 3-point star on a Mercedes-Benz. It is a symbol of quality. General Motors could replicate the exact same car as a Mercedes. Those same people would value it less. In this case, it is the prestige of that 3 Point Star on the hood. It may be a sense that the inherent quality means the car will last longer. Ergo, it is worth more.
Secondly, bundling can create a perceived value. You have never skied before. You go into a ski shop to buy a pair of skis.
The astute salesclerk guides you to a “Beginner Ski” package. It includes pants, jacket, boots, poles, toque, gloves, and goggles. You went into the store to spend $xx and ended up spending 3 times that!
There was a perceived value. The single price of each item likely added up to more than the bundle price. Yet, the store owner made a much higher sale.
OK, so we know value is a perception. It is not objective. If it were, everyone would have the exact same reaction to the sticker price of an item. We know that is not true.
This leads to the second thing…
No One Cares About Your Costs
You enter the store, and the owner sits you down. He pulls out his Profit and Loss Statement, showing you all his costs. He explains how expensive it is to be in business these days. Yawn.
He shows you a modest and fair markup for his products.
Feeling good yet? No?
Why not? His markup is fair. It is even lower than you would expect.
You just do not care. Why not?
Because for one thing, he could be a poor manager. His staffing costs could be way too high. Material wastage is out-of-control.
I repeat. The store owner’s costs have no bearing on your buying decision.
With one exception! Buyers are acutely aware of abusive labour practices. Unfair labour practices can bring a decline in that perceived value.
This leads to my last point…
Lower Costs Does Not Equal Lower Price
You figure out a way to make your products for less. Lowering your prices is the ethical thing to do, right?
Deciding to lower prices could increase volumes. Or, invite more competition.
People value the end result of what you offer them. Your lower costs does not change their perceived value.
One of the points in the BDC Blog was to determine your markup from your actual costs. The problem here is obvious. Why should your customers pay for excess fat in your production?
Or, you may be leaving profit on the table they would be happy to pay for.
There is nothing wrong with low prices, low costs, high volume. The challenge is that you are competing with Costco, Amazon, and Walmart. And, you will not win.
I just read about a hardware business in the USA. The owner sent his team members to Lowe’s and Ace Hardware to check prices. He would then lower his. A better strategy would be to stock unique hammers and charge more, not less.
Here are the steps in the correct order:
- Determine the value you offer through the eyes of your customer;
- Set your price;
- Look at your costs. Too high? Sharpen your pencil. Consider outsourcing your production.
Thanks for reading…