One of the most important decisions you will make in marketing is how to price your product or service. So how do we settle on a price?

Information needed for pricing

There are three basic types of information you’ll need to set a price that will jointly maximize value for you and for your customer and the first piece of information is internal: what are the costs associated with making and selling the offering.

Cost information is important because unless you carefully track your costs you could end up accidentally selling your product at a loss.

The second type of information you will need to set your prices, your competitors prices. Competitors prices are an important source of information because your competitors prices are important inputs for your customers as they evaluate the attractiveness of your price.

The third and by far the most important type of information to consider when setting your price is the value your customers place on your offering. Ultimately your customers opinion of how much your offering is worth is the most important thing.

Making and selling

Granted there are a few settings in which it may make sense to lose money on some sales, but those settings are relatively rare and always part of a larger strategy in which sales of other offerings make up for those losses, if not the company tends to not stick around for very long.

So it is always important to track costs carefully and to consider costs when setting a price. However even though cost information is important to have when you consider everything that goes into smart pricing decisions it turns out that costs are among the least important bits of information.

Your competition

Cost information sets a floor on what prices are possible for the firm, but your costs tell you nothing about how your customer will evaluate your prices. This brings us to the second type of information you will need to set your prices, your competitors prices.

Competitors prices are an important source of information because your competitors prices are important inputs for your customers as they evaluate the attractiveness of your price. But be careful, the relative importance of competitors prices will depend on the type of market you are in and the type of product or service you’re selling.

If you are in a market with lots of competitors and it’s very easy for your customers to compare prices, think airline tickets or jars of peanut butter, then keeping up with your competitors prices will be extremely important because your customer will almost certainly be using that information to evaluate your price.

On the other hand if you are in an industry where it’s difficult to compare prices across suppliers or were offerings are highly differentiated making it difficult to make apples to apples comparisons between offerings well then up-to-the-minute tracking of competitors prices will be relatively less important in determining your pricing strategy.

The second piece of advice about analyzing your competitors prices is this make sure you are using the right set of competitors. Your competitive set should not be determined by any kind of market designation for example not liquid hand soaps. Your competitive set should not simply be other brands in your category as defined by major retailers or distributors.

Instead, your competitive set should always be defined by your customers, what other options are your customers making comparisons to when they are considering your product. If there certain brands in the same category that your customers would never consider buying then those brands are not in your competitive set and their prices are irrelevant.

So, remember, your competition is determined by your customers.

The value of your offering

The third and by far the most important type of information to consider when setting your price is the value your customers place on your offering. Ultimately your customers opinion of how much your offering is worth is the most important thing.

Costs are important to know so you don’t go broke and competitors prices are important to know because they’ll often establish reference points for your customers evaluations.

Ultimately your goal is to price your products in such a way that your customer thinks what you’re selling is worth what you’re asking for it
that’s the most important lesson in pricing know who your customers are and price according to what they see in your offering.

Of course, sometimes you have more than one target customer that you’re selling to and those groups of customers may value the offerings differently. This can be a problem. If one group is willing to pay two dollars for your widget and another willing to pay one dollar what you do? You want to sell the both groups you have to price at one dollar and just leave all that extra money on the table right?

Sometimes, yes, you would just have to lose out on that extra profit and on some sales in order to secure a larger number of sales overall, but sometimes it is possible to identify barriers in the marketplace that differentiate customer groups according to when, where and how they buy, and once you’ve identified those barriers it’s often possible to charge these two groups different prices for the same or for substantially similar offerings.

This practice of charging different groups of people different prices is generally known as price discrimination. In general, people are much more price-sensitive when they’re spending their own money on vacation than when they’re spending the company’s money to visit that account in Akron.