Quit losing money. Abandon the cost-plus pricing model
If you’d ask me to be honest, pricing is kind of like alchemy; part black magic, and part arcane data science.
A T-shirt that costs $2 might retail for $29.95 — that does not make any sense at all now, does it?
But actually, it makes perfect sense.
The de-facto model for pricing has been (for millennia), the cost-plus model.
Take your product’s costs, and add a margin. Apply to your entire inventory. This cost-plus model sounds pretty simple and straightforward, amiright?
Grow up. That’s not how the world works
Any retailer worth its salt prices its products by value.
Because psychology. A buyer pays what she/he thinks is a fair price for the value of the product, not the what it actually costs to make the product.
In most cases, cost should not even play a part in your pricing model. If at all necessary only use it to make sure you don’t price below your costs. (which is pretty evident)
To actually set a price, you’d probably need to look at these things:
Competitors: price-to-value ratio: Try to evaluate for yourself what you think is the true value of your competitors products, then compare that to the price. Ask around, and talk to people. Often times, people are really willing to talk about a competitor’s products to you.
Customer base: willingness to pay: This is kinda tricky to do, but one of the things that you have to keep in mind is customer’s tendency to “anchor”. Anchoring happens when there is limited information on a product, like reviews, or other good metrics. People eventually turn to pricing as a means to evaluate your product.
A really good way to do this is to set a realistic price that’s on the high end, then create an offer that’s a little bit lower. The key idea is to create the experience of a good deal, (and hence great value)
Psychological pricing effects: The customer’s perception of your products’ prices is the basis of psychological pricing. This strategy appeals to their emotional side, rather than their rational side. The pricing may aim to strike a thrifty note with a bargain or stir up feelings of prestige with a high-end item, or pricing a product at $9.99, instead of $10, to associate the product at $9 instead of $10.
Use psychological pricing to choose an appealing price based on the needs and wants of your target audience.
Now why isn’t cost included? Because cost shouldn’t affect your price. If you try to quantify all the costs of doing business, you’re going to WAY skew your pricing.
Cost is considered when doing the original business case for the product— when you did some high-level analysis to determine whether the line would be profitable based on estimated sales figures and an estimated price.
By following a cost-plus model, you’d actually risk leaving money on the table. This isn’t only lost take-home profit, but funds that you’ll need in order to grow.
Why lose growth capital? Often times, adjusting your pricing model can actually help you grow.
There is a long history of companies that became obsessively focused on cost, at the expense of providing a product or service of value to the customer.
The fact of the matter is you can make a pizza so cheap no one is willing to eat it.
I run Business Growth at Semantics3, where we help create many of the product-specific datafeeds used by many e-commerce businesses to create their pricing models. Talk to us to find out how we can help your business!
Published at: August 18, 2014