If we had perfect information about our market, and repeat sales of the same item, we can experiment. For example, with gasoline sales, we can try small increases and decreases in price around the average, to see how our margins change. Incidentally, the total margin depends on profit per transaction x number of transactions, so one option or the other may win.
With business to business sales it is very different. Usually, we have very little information about our competitors’ prices and it may be rare that we sell identical solutions.
So how do we decide what the right price is?
Cost Plus Pricing
The first thing to make sure is that we cover our costs. To do this, we need to know what our costs are. This requires a specification that includes everything we need, including time to sell our solution and put the quotation together.
Once we have a good idea of our costs, we can add a standard margin, say 10% and hope that the margin pulls though to the bottom line at the end of the deal. For this method to work, we have to make sure that every single thing is included in our costs. We might choose to put and extra few percent in to cover things that we haven’t thought of, or unexpected expenses.
This is a safe and relatively straightforward method of pricing. Assuming our costs are equal or lower than our competitors, and that our margin (say 10%) is close to the industry average, we should end up with a competitive price.
The major downside is that we might have been able to charge much more. If our offer includes essential benefits that our customer needs, but that our competitors cannot offer, then our customer would expect our price to be higher than our competitors, regardless of what our costs are. It is quite possible that they would be prepared to pay a premium for those benefits. That would enable us to push our margin much higher than the industry average, maybe above 50%.
Pricing to their budget
The next thing we want to make sure, is that we are close to the maximum price our customer is willing to pay. We can ask about their budget. People often think this is a difficult thing to ask, but it happens every day. Most customers think it is a natural question, otherwise how will we know how much quality to build into our solution. There is more help on finding out their budget here.
Now that we know their budget, we can target our price to fall, say 10%, below their budget. The great thing about this, is that we know they can afford to buy our solution. The danger is that our competitors may come in at a lower price than our offer.
Finally, we want to make sure that, compared to our competitors, our customer thinks our solution gives them the best value for money.
This may mean that are our price is the highest, but our customer agrees that they are getting more benefit for the higher price. And the extra benefit has to be something they are prepared to pay for.
This is the gold standard for how to price a product. We have now disconnected our price from our costs. We still have to know that our price exceeds our costs, but how much it exceeds our costs is up to our customer’s perception of the essential benefit that our solution provides. In unusual cases, our price may even exceed our budget.
So, we now have
- a price that we know we can make a profit from
- a price that is within our customer’s budget
- a price that our customer considers provides better essential value than any of our competitors.