Let’s face it: pricing is tough. Often, entrepreneurs err on the side of pricing a product too low out of fear. They’re worried that they won’t be able to make a single sale and end up undervaluing their brand.
Because of this, pricing strategies tend to be overly simple. Rather than researching a competitive price point, founders set arbitrary, low-enough price for their product. In doing this, they miss out on a critical opportunity for market- testing to prove demand and validate their assumptions on pricing.
Thankfully, there are a few steps you can take to put your pricing through its paces, and avoid jumping into a pricing decision based on your desire for immediate customers.
Look at your competitors
A good place to start thinking about your startup’s pricing is to take a look at your direct competitors. How much are they charging? How have they set up their pricing models?
This is a great first step, but don’t end your research here and set a price solely based on your competitors’ prices. In doing so, you’d be assuming that your customer is familiar with your competitors and knows exactly how their pricing stacks up; in fact, very few products have a well-established price that everyone knows (like gasoline).
Also, keep in mind that price isn’t the only factor that goes into a purchase decision. Quality will go much further than price. Who cares if your competitors’ products are cheaper if they need to be replaced five times faster than your product?
Create value through pricing
The next step in pricing is to consider your brand and the image you’d like to form in customers’ minds. Are you an affordable staple, or would your product be considered a luxury item? If yes to either, then a higher price might be in order.
Percent change in quantity demanded of an item / percent change in price of that same item
It’s important to keep price elasticity in mind when deciding on a price. Gasoline is an excellent example of a good with low elasticity – an item with low (a quotient less than .5) price elasticity will sell more or less the same quantity regardless of price increases or decreases.
Alternately, items with high price elasticity (a quotient greater than 1) will sell less as the price increases. An example of a product with high elasticity is a diamond bracelet. It’s not an essential everyday item, and if it’s price is increased greatly, many people will choose not to purchase it.
Be flexible and ready to make adjustments
Finding the profit maximizing price (the point at which your startup makes the highest total revenue without choking demand off) is truly a guess and check process. Agree with your founding team to select an inferential price and adjust until you get it right.
Repitch former “no’s”
As you adjust pricing, it’s worthwhile to re-approach potential customers who had previously rejected your product; new pricing is a great hook to get in front of someone for another swing at gaining their patronage.
Along the same lines, current customers should be phased into new pricing – but only if it benefits them. If the new prices are lower, convert your current clients. If the new prices are higher than before, leave your current customers’ pricing models alone as a reward for their continued support. They’ll appreciate it.
Price wars: just don’t do it
When you hit a pricing sweet spot, your competitors may begin to drop their prices in an attempt to steal customers away. However, it’s important not to engage in price wars. These will throw your business into a tailspin of decreasing profits and revenue.
As mentioned before, your business isn’t competing solely on price. Add value, and your company will make it through these competitive tactics.
Profit margins don’t matter as much as variance
After following the above steps, you should be close to figuring out your initial pricing. Now is the time to consider profit margins.
Your profit margin is the differences between the total amount of cash earned from the sale of a product and the amount of cash it took to create the product. (For instance, if you spent $3 producing a product and sold it for $5, your profit margin is 40%).
While profit margins are important (you don’t want to lose money!), maximizing the difference between costs and income is a much better way to ensure success. While a 40% profit margin sounds great, in the above case your net gain is only $2.
On a larger scale, if you’re selling a product that costs $60 to create for $100, the profit margin is still 40% but comes with a much larger variance. The larger variance allows for a greater amount of human error (which will likely occur at some point).
What’s most important is to find the price at which your product makes the most profit, and produce efficiently to increase profit margins.