In an earlier post we discussed whether price should be set or discovered by entrepreneurs? If you have not read it, here is the link to it: https://rajshankar.wordpress.com/2013/12/10/pricing-for-entrepreneurs-is-price-set-or-discovered/
Extending our discussion, let us understand how price can be arrived at! There seem to be three broad approaches that entrepreneurs can use to discover price. While the first two methods seem to tilt towards setting price, the last method can lead to price discovery. Since setting price is easier, most entrepreneurs resort to the first two methods.
The three approaches are:
- Cost based Pricing: This is probably the easiest method to set the price for a product or service. Since most companies can identify what they are spending to make a product or service, they tend to add to it a comfortable margin and set a price. While it may seem easy to find the cost of making a product or service, in most cases they are only close approximations. But since scale of operations is small this does not seem to affect the overall financial statements in any way.
- Peer Pricing (market/industry): The second most commonly followed approach is to find what the market is currently paying for the product or service. If there is no direct competitor, substitutes are considered as close approximations. If an industry has players supplying at varying price levels, then entrepreneurs attempt to place themselves closest to the competitor they think they would like to be like. Many times the entrepreneur simply prices their products / services a little above or below depending on their imagined positioning.
- Value based Pricing: This is probably what every entrepreneur wants to do, but doesn’t. The reason is because it is not as passive a method as the above two. In this method the entrepreneur needs to do a lot more homework on how the potential customers perceive the benefits, the product / service and what they think about the importance and urgency of the solution. This method also requires some experiments with pricing. All of this over time will help the entrepreneur discover the right price for the product or service.
These are probably the most common ways in which price can be set or discovered by entrepreneurs. Each method has its own pros and cons with respect to arriving at the right price. Pricing seems to worry a lot of entrepreneurs, but it simply remains a worry and does not proceed beyond that. In fact many entrepreneurs don’t have a plan out of the problem. They remain with the worry, cry over it, empathize with others about it and feel glad that it is a larger problem shared by the entrepreneurial community. But what they don’t realize is that the smart ones are quickly taking the risks early and trying to find the right price for the business. The question then is how much gross margin can the entrepreneur generate from the business? The more the merrier – isn’t it? How else to do it but by discovering what customers are really willing to pay for it?
Think on this till we discuss more on pricing in the future blog posts!