What is the role of product or service cost in the conversation about price? The truth is cost has little or nothing to do with sales price. The marketplace, that place of competition between buyers and sellers, sets price. The price you can obtain for your product or service is based on perceived value.
CEOs tend to start their conversation about pricing with their accounting department. Truth be known the best starting place is your marketing department.
Is it important to know your costs? Absolutely. But for reasons you may not imagine. You don’t need to know your cost to establish sales price. So why do you need to know cost?
- To know if you are selling below it
- To sort thru your most and least profitable products or services, thereby knowing where you should focus your marketing efforts
- For the same reason you need to know any cost, to manage it
So if you don’t determine price from cost, how do you determine price? Based on what the market values your product or service? And how do you know that? If you have the resources, you may be able to get this data from market research. Guerrilla research on your competition is a great starting place. Trade associations are also good resources for price as are key vendors. Think of whom you know who understands your market place. Of those people, who can you call on that will help you in your quest? Thereafter, trial and error can prove very valuable. If you aren’t getting any no’s, then it is likely your price is too low.
Price is one of the factors that helps people choose your product or service. Low price engenders feelings of low quality and low value. High price, likewise high quality and high value. When evaluating your pricing, know where you want your service or product to be perceived on the quality and value spectrum.
Another great question to explore is how large is the marketplace at a given price point? You may be able to get a very high price for your product or service, but find only a handful of buyers. At what price are there sufficient quantities of buyers to build a marketplace around?
However you choose to set pricing, use trending analysis to track your results. Trailing 12 months charts of sales and gross margin with notations about significant changes are critical in knowing if a change in pricing strategy is effective. Too often as CEO’s we get all too focused on the top line and forget, it is all about the margin. Be sure you are watching both, in tandem with each other.