CEO: “How do you set price?”
This question was the last question of the interview. I honestly thought the CEO was trying to trick me, but, because I was at a loss, I answered honestly.
Me: “You don’t. The market sets the price.”
CEO (laughing): “Yes, but my sales guys try to find out the cost of each item and build up.” (That explained the locked door on the pricing analyst’s office.)
Market Forces: Good or Evil? Ultimately, you don’t set a price; the market sets the price for everything. An offering – product or service – is worth what people will pay for it. Therefore, it’s important to determine that market price.
You want to find that sweet spot between being outrageously overpriced and leaving money on the table. (This is also true for job seekers.)
Check out competitors. What are their prices for like or similar items? If your product is better, you should be able to command a premium over their price, but be realistic about how much better and how much of a premium.
- For job seekers, look at Salary.com, Glassdoor.com and similar sites. Other candidates are your competitors, and information is power in salary negotiations.
History is a good indicator. Look at past sales results for your offerings or similar ones from competitors, but realize that the market changes, as do consumers and their preferences.
Not Cost Plus. Though you should verify costs and be sure you are making a profit at a given price, setting price by building up from cost is a mistake. (Unless you are the government, cost-plus pricing – where you add a flat percentage of profit to the final cost – is not a realistic pricing strategy.) By being inwardly focused, you are ignoring the boss, your customer.
- Job seekers, the analogy would be expecting a salary that you need to support a certain lifestyle. Someone once said to me, “I need a raise to buy the new BMW I want.” Not a strong argument. No raise.
Instead, look outwardly to the market. Analyze competitors, research consumers, and/or use test markets to determine what price the market will bear. You want to set your price as high as possible, but you also need adoption by a critical mass of people for scale economies. (See product adoption curve for more.)
Scarcity Premium. LeBron James and the Apple Watch (when introduced) and a Ferrari have this in common. Basic economics indicates that the more scarce a product or service or person’s talent is, the more valuable it is. Greater value commands a greater price premium.
Me-too? In contrast to a premium price, a parity product must accept the price set by others. Often, this low price will be driven down further by new entrants whose costs are lower as they are starting out. (Innovation and differentiation are the only escape routes from this downward spiral.)
- Job seekers, distinguish yourself by highlighting your exceptional skills, talents, experience, and accomplishments – those things that make you unique. And more valuable. You will be rewarded with better positions and higher salaries.
Penetration vs. Skimming Pricing. These two very different strategies are applied to innovative new products (not me-too ones.) In a skimming price strategy, the company charges a very high price to the initial group of customers.
Think about the iPhone upon introduction. Initially, it was priced at about $600 because a small niche was willing to pay almost any price to be among the first people to own it. As that group became saturated, the price was driven down by the need to attract the next, much larger group of customers. (This dramatic price reduction within a few months angered some initial customers.) Other examples of skimming pricing would be the Mini Cooper and Sony’s introduction of the first HDTV in 1990 for about $43,000.
A very different pricing strategy for new innovative products is penetration pricing. By setting a relatively low initial price, large numbers of people are spurred to quickly adopt the innovation. The hope is that this will block competitors from gaining a foothold and market share, and the product or service will dominate the market and become the standard for the category against which all others are judged.
Think about Amazon when it started. Prices were relatively low and very competitive, and many people quickly adopted this new way of shopping. That made is difficult for competitors to woo away consumers, and Amazon grew rapidly. Other examples would be Netflix and Wal-Mart.
There are many different thoughts on pricing, and only trial will provide certainty about what works. Follow these steps:
- Keep the consumer/decision maker in mind
- Do a realistic evaluation of the benefits of your offering
- Perform a competitive analysis for direct competitors and substitutes (offerings that serve the same general need)
- Test various pricing strategies, such as skimming, penetration, and promotional (lowering price for a short time or in conjunction with another offer)
- Drive down costs to prepare for increased competition and pressure to lower prices
- Win the pricing game