The pricing of products and services delicately connects buyers emotions with products and is a critical aspect of marketing. Unfortunately, it seems to be the most overlooked, misunderstood, and poorly treated.
In just a few words – even sometimes a number – it seems to convey volumes of information about the product, company, and expected experience.
Think about what you might expect from a hotel room that is $400/night; compared to one that is $40/night.
The trick to pricing is that it actually communicates very little, but what is communicated triggers deep emotional connections and responses to our current beliefs. This is where entrepreneurs and sales people often get themselves into trouble, but we will touch on that in a bit.
To keep things overly simplified; there are two strategies or models used to establish pricing of a product or service.
1) Cost + Mark-up
This tends to be the default in retail, distribution, and most scenarios where there is a tangible product exchanged. It is a direct reflection of (or reverse-engineering of) our accounting systems where we add a profit margin to our cost of goods sold.
Here is how it might look in a traditional manufacturing-to-retail model. If it costs $10 to make, sell, and deliver a widget, we might sell it to wholesalers in bulk for $15 each. They would sell it to retailers for $20, who would sell it to customers for a Suggested Retail price of $40.
We also see this in many service industries where they modify it to: parts + labor + mark-up. Auto repair, construction (even construction of multi-billion-dollar projects)
I find this model is heavily dependent on scale (unit prices decrease with higher production), it lends itself to commoditization and standardization (things become more similar, more boring, and available at lower cost), and is easily impacted by external forces (changes in competitors and suppliers drive your cost as much as your own operations).
This approach tends to be more common with luxury items, collectables, experience purchases, and technology services. Here we still use the same accounting system to track and report cost of goods sold, but the approach disconnects price from the costs to produce products or services. The price is determined on the value of the service/product/experience to ideal buyers.
This model is extremely subjective and sensitive to audience selection. When the first Barbie dolls hit store shelves in 1959, they sold for about $3.00. One of those same dolls recently sold at an auction for $27,450!
On the other side of the spectrum, technology and subscription services often operate at huge transactional losses for years as they grow their number of users. This way we can have access to millions of dollars worth of software or content while only paying $9.99 per month.
Professionally, I am more experienced and prefer the latter though both approaches have situations where they work well, and situations where they fall short. The art of pricing is to align the strategy, with the number, with the story, with the audience, with the company (operations) in a way that works.