Growtion Formula: #03 Product Pricing
How much should your Product cost?
It’s one of the biggest and most important decisions that you’ll make. As such, you’re going to need to spend a little time mastering some of the basics of economics; specifically, supply and demand.
You’ll know much of this already, I’m sure. If you don’t, you might want to mug up on it quite quickly. The essence is that if there’s a plentiful supply – loads of competition – that will drive down price because customers can go elsewhere and get your Product more cheaply; every supplier is looking to shave a little more off their price for the same Product, so the buyer has the power.
If there is a plentiful demand – everyone wants it but there are too few available – then prices rise steeply and, as a supplier, you can make a hefty profit. Think those expensive Christmas toys that always sell out because manufacturers know how to generate the playground hype and max demand whilst restricting supply.
One of the critical factors in Pricing is Product quality. If you are looking to provide a premium or luxury item then you should – should – be able to charge more. However, that is still dependent on the core market basics; is there a demand for the item and are others supplying much of it?
Another key element in Pricing is your own cost. How much is it costing you to produce the item? How much is it costing you for Marketing, for Sales? Generally, for online services, costs tend to be lower – that’s why the likes of Amazon generally have the cheapest of pretty much everything. They can create massive warehouses strategically placed on transport networks so that rent is cheap and home delivery still doesn’t cost more than siting a shop near your house.
However, certain physical shops continue to flourish. In the UK, High Streets can be dominated by gambling outlets, charity shops, estate agents and barbers. For the purposes of this Element, it is worth taking a look at each of these Pricing models.
Gambling outlets generate a lot of revenue from a relatively small number of regular clientele (you may wish to call a proportion of them “addicts”). Their prices – “odds” – are generally set by reference to likelihood of having to return payments (“bets”) with interest (“winnings”). Competition is fierce and also online.
Having gambling machines with high one-off potential payments draws people from their home screens to the shops. These “Fixed Odds Betting Terminals” (FOBTs) can make £1,400 each week for the outlet. That has led to local councils refusing to allow new bookmakers to open in areas where there are already – according to the councils – enough of them. It is easy to make an argument that supply is being falsely restricted in this case, meaning that Pricing of these FOBTs in particular is skewed upwards.
Charity shops benefit from a differential tax regime, meaning their rents are covered more easily by the small number of items that they sell – and which cost them nothing to create, as they are donations. Thus, customers can discover incredible bargains and anything that the charity sells becomes “profit”. Demand is still relatively low, supply high, but costs are not an issue in the main as even wages are not paid to the vast majority of staff volunteers. Supply is being falsely increased in this instance and therefore Pricing is low – perceived bargains can be found.
Estate agents retain an element of specialism that is valued – the ability to sell a consumer’s most-valuable asset, their home. As such, their Pricing has tended to be high – where perceived specialisms are present (doctors, bankers, footballers) Pricing can rise due to limited supply. Historically, estate agents have survived the cull of middlemen from UK towns – recruitment consultants and travel agencies are almost exclusively online these days – because of their ability to retain an air of expertise that one cannot easily replicate online.
In particular, the correct valuation of a property and the negotiation with a buyer to maximise the deal price is something that the vast majority of people do not have the confidence to undertake themselves. Failure in it will lose many thousands of pounds, perhaps the most that one may lose in one’s lifetime. So using an expert in this transaction – the biggest – is understandable. Pricing is high due to perceived lack of supply. This can pay for expensive office rents in prominent locations. Recently, as has been mentioned before, this business model has come under pressure from online operators who have been able to convince homesellers that this expertise is replicable from afar and Pricing has decreased as a result.
Barbers and hairdressers are sustained by the rudimentaries of human existence. Hair grows, every day, on the vast majority of people. It is not socially acceptable for most of these people to leave their hair uncut. Therefore, the problem that hairdressers solve is self-explanatory. Demand is high and supply rises to meet it – more barber shops are in more populous areas. There is currently no mechanism for online operators to give you a virtual haircut. Price is simply dictated by this balance of supply and demand. This is a perfect market.
Your market will have its own influences regarding what you can and what you cannot charge. It’s time to start thinking about your own Pricing opportunity.
Whatever your particular Product, its Pricing opportunity will be to find that sweet-spot where it sells the optimal volume for the most profit. Note that this is not “the most volume for the most profit”. Selling high volumes can be made easy by slashing prices. But low prices bring considerable problems – and huge risks – in the medium- and long-term.
Unless you are a charity shop with artificially low costs, charging a low price will put huge pressure on you to consistently sell more. You will have fixed costs – your own salary, perhaps, some advertising, website hosting – and these need to be paid from the variable profit that you will make on the number of products that you can sell.
In addition, once you publish a price to the market it is unbelievably hard to increase it by much. Wherever you start, increasing it by more than the rate of inflation each year will give you plenty of negative feedback, publicly shared on social media. You need to get this right at the start.
Another risk of low prices is the “race to the bottom”. If your outstanding feature is your low price, that it something that others can replicate relatively easily. If you charge £15 for something that is available elsewhere for £20, that might feel like a significant benefit to your customers. Many might switch. If that costs you £14 – you’re making £1 each sale in profit – you might think that it’s worth it until you’ve “bought the market”, got rid of a few competitors and then you can edge the price back up.
But say one of those competitors aggressively slashes their prices to £10. They might call it a “Special Offer” and leave the price there for a while. You will probably have to follow suit or risk your business not generating any revenue at all. At this price, however, you’re losing £4 per unit. You might survive for a while. However, having started a “Price War” your competitors – probably also losing money at this point and certain to have had to have some tricky conversations with their ongoing clients, as to why they’ve not been charging this low before – are unlikely to simply allow you to gently ease the price back up to where everyone makes a profit again. They would rather squeeze you until you’re gone from the market.
Do not underestimate the potential for this to happen.
My final point – and there is no apology from me for labouring this, as it’s too important and all-too-tempting to use Pricing as Unique Selling Point (USP) – is that if your Price is too low then you will be working very, very hard for not a huge reward. Whatever it is that is driving you to create or renew this Product, you have a duty to yourself to ensure that you profit from it. Working every hour for very little reward will tire you, dispirit you and make it much harder to display success to your stakeholders.
YOU CANNOT BUILD A SUSTAINABLE BUSINESS PURELY BY DIFFERENTIATING YOURSELF ON PRICE.
There. It’s all out now. Thanks for listening.
Quick look at the flipside – charging too much. Rather obviously, the risks are that no one will consider it affordable value. If the quality of your Product is such that it costs you much more than your competitors to supply it, then you are going to have to be majestic in Marketing and Sales to convince that the high Pricing is worth it. It’s not impossible to justify – we can all think of extraordinarily expensive luxury items that get High Net Worth individuals buying – but it will be hard, particularly at the start.