Are you 100% certain your company is charging the right price for its products or services? Every purchase decision ultimately comes down to price. Optimizing your price point will profoundly impact your ability to generate cash.
Survey the Market
Survey the market for both competitive and substitute products. In addition to doing online searches, speak to current and potential customers. Find you how they are currently solving the business problem your company is trying to solve. What are they paying? What value do you think they are getting? A great way to get these folks to open up is to approach them as a researcher and not a salesperson – people generally like to help out others.
Make sure you include substitute products. There is more than one way to solve a problem. If you want a clean car, you can do it yourself at virtually zero cost, or you can pay for a car wash. The car wash can be automatic or by hand. The value to the customer is either time saved or the quality of the wash. The average car owner may want to spend a few bucks to get a quick wash and save time. A vintage car owner may pay more for a hand wash to get a shiny car to show off. Knowing what your customers value and will pay for goes a long way in setting the right price.
Test Pricing Through Discounting
If you are struggling with a price point, err on the side of a higher list price and use discounting to test it. First, set a baseline sales volume without a discount. Next, promote different discounts. Measure the discounts against the baseline price. Make sure you use consistent time periods and there are no other variables (like holiday season) that will skew the results. What you are looking for is a price point that generates more cash flow than the baseline. You can put the results in a table like below:
In this example a 5% discount generated a 10% lift in sales and generated $35 more cash flow than the baseline. While 10% and 15% discounts generated higher unit sales, when you factor in costs they actually generate less cash flow than the baseline. The 5% discount is the optimal price point and you could consider adopting it as your permanent price.
Robert Schindler, a professor of marketing at Rutgers University, performed a study of $0.99 vs $1.00 pricing. Called “just-below pricing,” he found that a $0.99 price point outperformed a $1.00 price point. This is because people focus on the left-most digit. While people will not perceive a big price difference between a $20 and $25 item, they will perceive a big difference between $19.99 and $24.99.
There is one exception – luxury goods. When a consumer is more concerned with quality over price, a price rounded to the nearest dollar outperformed just-below pricing. Consumers felt a $0.99 price point suggested an item of lower quality.
Pricing is one of the most important decisions a young company makes. Once set, its easy to lower and difficult to raise. Spend some time doing your research to make sure the price you set is the best one for your business.