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An Essential Guide to Pricing Strategy

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Oct 20, 2012

Pricing is the most important aspect of your business. Period. Don’t believe me? Well, we went through a pretty thorough analysis of this, but to summarize: a 1% improvement in your pricing strategy equates to an average increase in profits of 11.1%. It’s that important.

Beyond the numbers though, think about it this way: every economic transaction is a trade between two parties with price being the exchange rate for the value each of the individual’s is receiving. If I run a moving company and charge someone $50 for an hour of work, then the “exchange rate” is $50 for one hour of moving. As such, that price justifies that my hour of work is worth that much. Similarly, your prices and pricing pages must boost and justify the value you’re providing for the amount of money you’re charging.

What’s interesting though is that you can’t validate your value, only the customer can, because they’re the one putting down money to purchase what you’re selling. As such, you must utilize customer value to establish value based pricing. This is what distinguishes companies that price their products correctly, and those that lose revenue by pricing incorrectly.

In order to put you on the right track to pricing correctly through value based pricing, let’s explore more about setting up your revenue model, as well as finding a customer’s willingness to pay or in other words, the value they place in your product.

You must charge customers along your value metric

A value metric is the value your customer receives out of your product or service. If you’re selling eggs, then your value metric is one egg. If you’re selling productivity software, then your value metric is time saved. With that in mind, not only must your price and your customer’s willingness to pay for the value you’re providing be equal, but you also need to charge your customers in the appropriate manner. You wouldn’t charge someone for a months’ worth of coffee if they only wanted one cup.

Likewise, remember that your customer is trying to exchange his money for the unit of value he wants. It is your job as an entrepreneur to determine what exactly he finds valuable and what his perceived exchange rate is for that value. Furthermore, you should think of this willingness to pay as a sliding scale, the more of that fundamental value you provide, the higher your price goes and the value metric you’re pricing on should be easy to understand.

For example, look at Rejoiner.com’s pricing page (below). They capture abandoned carts for e-commerce sites through email remarketing. The value they’re providing is the number of carts captured, but that’s difficult to understand and track. As such, they’re charging based on the amount of traffic they’re customer receives, as they can reasonably assume that the more traffic a site receives, the more abandoned carts they’ll be able to capture. As the traffic goes up, the price goes up, because Rejoiner is providing more value.

Pricing is a process that requires customer data

Once you’ve figured out your value metric and revenue model, you’ll need to figure out the actual number to put on the page. There are a number of ways to determine your customer’s willingness to pay, but they all involve actual customer input. Things like cost plus pricing or competitor based pricing can be beneficial. Yet, the only person who will tell you how much you’re actually worth is your customer.

So, where do you start? Well, if you’re already selling something, then your closed-won and closed-lost rates are great starting lines. People are buying or choosing not to buy based on your price already, so you have some validation. An easier way is just to ask them. Yes, ask them. Customers are more than willing to engage you in a value discussion, as long as you ask.

To make things a bit more scientific, consider utilizing a value based pricing research methodology by conducting price laddering or van westendorp studies. Price laddering is exactly how it sounds, where you ask a customer if they’re willing to pay $X for a product, and if they say yes, you ask them if they’re willing to pay $X+1. The process goes until the customer says no. Van Westendorp studies ask the customer about their price sensitivity in ranges, allowing you get to a better pinpoint of where they’re willing to pay.

All methods have their drawbacks, but the big thing to keep in mind is that in the case of pricing, some data is better than no data. As such, you need to keep the discussion open with your customers. Simply put, by pricing your product based on its value to your customer, you are likely to increase profits and customer satisfaction.

To summarize, pricing is a process that requires data. It’s the most important aspect of your business and can be exceptionally confusing if you don’t follow the right path. To learn more check out our Pricing Strategy ebook or sign up for our free Pricing Page Bootcamp course. Both expand on the ideas we discussed above and will get you closer to the right track to capturing all the cash you’re leaving on the table.

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Author Bio: Patrick is CEO of Price Intelligently a software company revolutionizing how businesses price their products and services through technology that leverages existing and potential customers to determine true value. Price intelligently was created because too many companies are relying on faulty data, competitive benchmarks, or "gut feelings" to set the most important lever in their business.

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