Pricing may be the most important decision that the entrepreneur makes. Often this decision is rushed and done by the seat of the pants. Most entrepreneurs think pricing is easy.
Many businesses use mark-up pricing. Mark-up pricing uses some multiple of cost, such as three or four times the “estimated cost”. The entrepreneur says, “If it costs a dollar to make the widget, I need to sell it for three or four dollars. Hey baby, we are living large!”
Whoops! Look back a few words and you will see the word “estimated”; most entrepreneurs don’t know what their actual costs truly are. Often they under-price their products since cost accounting at small firms is only the guessed sum of direct materials and direct labor (if they track it).
Another common pricing technique is to price like the competitor or maybe a little below. Some call this market pricing. Since when is the guy down the street a pricing genius? This is really dumb.
A better choice would be “perceived value based pricing”, which is pricing for a product or service at a level that reflects the potential savings, the highest satisfaction level, or the maximum use that a client will receive from the purchase and the use of the product or service. Overall, price is set at the highest level that your target market is willing to pay given these benefits.
This type of pricing reflects a sustainable competitive advantage, where there is little competition. This is niche market heaven. But, be sure that your competitive advantage is real and defensible, or you have got trouble on the way.
How much is too much to charge when utilizing perceived value based pricing? Look for tear stains on the checks you receive from customers; if it hurts them to write you a check, then you are charging too much. If that is the case, you won’t keep them as customers for long.
John Bradley Jackson
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