the art and science of pricing
March 20, 2023
There comes a time in the life of every entrepreneur when they have to set the price for their product or service. And it’s almost always a challenge.
Oftentimes, novice entrepreneurs don’t know their numbers and the market’s benchmarks. They don’t understand their costs, their production hours, their conversion and retention rates, or their margins. All of which are important to know to set the price.
For some, charging money for the first time often causes them a lot of anxiety because they are insecure and most have a poor relationship with money. It’s not unusual to hear the dangerous, albeit well intentioned, advice that they should charge their worth.
DON’T charge your worth
Charge your worth is a dangerous narrative for at least two reasons.
First, it perpetuates the fallacy that we are what we do and further entangles our identity with our work, which inevitably leads to self-esteem issues.
Two, It’s a self-centered view that implies that people pay full price because they think we're worth it. They don’t.
Your pricing isn’t a reflection of your worth, but a token of the value that customers attach to your product or service. I believe this misconception is part of the insecurity and anxiety around pricing. You make it about yourself and not about customers.
If you shouldn’t charge your worth, then how should you charge?
There are three schools of thought, which are important to consider:
1. Input-based pricing
Companies that sell products would calculate the cost per unit of production, while service-based businesses would calculate their hourly rate and multiply it by the total hours of production. Once you know how much it costs to deliver your product or service, add margin as your profit.
2. Output-based pricing
Here, you set your price based on specific deliverables. For service-based businesses like a marketing agency, for example, you could set prices for deliverables like logos or a new website, and those prices remain more or less fixed regardless of the impact a new logo or website could have on the customer’s business.
3. Value-based pricing
Price your product or service based on the value that you create for the client and not how much it costs to produce, how many hours it took or what the deliverables are. Sometimes the value is quantifiable. If I make or save your business $50,000 dollars, I would charge you a percentage of the revenue or savings. Other times, it can’t be quantified. Whatever your client is willing to pay reflects the value they attach to it, like a $120,000 watch that costs a fraction to produce.
Value is subjective
Whatever route you choose, recognize that value is subjective. It lives in the mind and heart of the customer, and is often determined by a number of arbitrary factors not directly attached to costs, quality or performance.
People don’t pay because you are worth it, because they understand how much it costs to produce “better” work, or because your price is an absolute measure of quality. They pay what they are willing to pay based on the value they attach to your product or service.
Ultimately, it’s important to know the numbers that drive your business but you should spend a disproportionate amount of time understanding what problem your customers are trying to solve, their needs and wants, and the aspirations that drive them. Those are better filters to determine value, and therefore price, than cost, quality or self-esteem.
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