Archives by tag ‘pricing strategy’

How much can I charge for my product?

By Jose on 18.12.2009 // 2:44 pm in General
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There are some doubts that insistently come up in most entrepreneur projects. Many of them are related with strategic aspects (hardly ever the new entrepreneurs’ strong point) and other are related with more practical aspects. One of these practical issues is price. It is quite common that when the moment comes to analyze a product’s marketing or when the services rates need to be established, the entrepreneur is not certain about how much he or she should charge for his/her product or service.

There are two types of pricing mistakes: overpricing and downpricing. Probably overpricing is the most harmful of the two. All in all, to put too high a price on a product or service can be the cause of unbalanced accounting even before starting the project, or even worse, it can make the project impossible to market. On the contrary, if the cost is too low other problems could arise once the company has started up (nevertheless we have to take into account that to increase prices is far from being an easy task).

When a consultancy type service is offered to do the math is more simple since the expenses incurred are low and “expertise” is what you are charging for. By expertise we mean the specific businessman’s knowledge (we just need to find out its market value). Nevertheless, when there are production materials and R+D processes, things become complicated because… how much does an hour of innovation cost?

We will go through many price fixing strategies in coming posts, but before that we need to recall the basic functioning of these mechanisms. When fixing the price of a product or service one needs to consider the costs, the product value and the desired profits.

First, we need to make sure that the price will cover the costs incurred by the item’s production or the service provision. At that moment we face a complicated challenge related with the product value: we need to understand the product value not as its real value but as the value that will be granted by the client. This is probably the most complicated and most difficult issue to unravel, since it involves deep research. The objective is to determine how much the competitors are charging and how much the client is willing to pay. Once we have these data, we just need to add the profits margin we wish to obtain.

The best way to understand how this works is through two different examples. The first one represents a classical case: the plumber or electrician who comes home to fix a breakdown. If we analyze his/her costs: transport should not be more than 5 euros for petrol and parking (worst case scenario) and materials should not be more than 20 euros if the problem is not a complicated one. Now we just need to add cost per hour, which we assume to be 15 euros per hour. In theory, the price should be around 45 euros (20 euros for the spare parts) but in reality the price is much higher. Why? The bill includes terms such as “output” or “labour” but the truth is that the repair value is higher than its costs for the client, and that is why these professionals can allow themselves to charge 100 euros or more for each job. Same thing happens in the case of mechanics and, to a minor extent, in case of IT technicians. A person whose house is flooded or who needs the car to go to work is willing to pay more than what the job actually costs, not because the provider is unfair, but because that’s the price for him as a client.

Other less common examples could be given such as a development or consulting projects. In this case and depending on the projects, the businessman’s costs are not necessarily very high (electricity, internet connexion and price per hour). Nevertheless, the cost of consultancy is not cheap, and the reason is the underlying knowledge which has to be paid for (plus IT programs, etc).

At the end of the day, in order to fix a price market research needs to be carried out to determine if our costs match market prices (i.e, if we are able to compete considering our costs) and to understand how much the client is willing to pay. Once we have this information, it all depends on the price we want to fix and for how much are we willing to work. That is of course a personal decision…