Almost nothing is more difficult, even for experienced entrepreneurs, than determining the ideal price of your product. Why can Apple charge twice as much for its tablet computers, although it has many competitors? Put the other way, why can’t other tablet computer manufacturers sell products for as much as the iPad? Just how much can you add to the price for a “brand name”?
Somehow, as an entrepreneur, you have to determine a price somewhere between what your market is willing to pay, and what is necessary for you to produce and sell your product. Yes, there are certain time-honored rules of thumb, but they mostly apply to older industries. For example, in retail there is “keystoning'” or doubling the price of a product you buy from a manufacturer and sell in a store. In consulting, it is charging your clients an hourly rate three times what you pay your junior consultants. For products that go through a distribution channel, it is four times the manufacturing cost. And in a construction project, it is time and materials plus an agreed-on profit percentage.
These traditional pricing models were used to account for direct and indirect overhead in making a product and getting it to market. The simplest, “cost plus” pricing, calculated the cost to produce the product and added a percentage for profit to arrive at the selling price. Unfortunately, this method left out the buyer, who might not be willing to pay the price, or might be willing to pay twice as much for a great product in short supply.
These traditional and imperfect models are slowly goIng out the window as more and more products and services are sold online. Where, for example, is the overhead in an Amazon store where there’s no lease and there are no employees? Online commerce has removed much of the friction (difficulty) of getting products to market. Buyers know this.
And the products themselves have become bits instead of atoms. What do those cost to produce? What is the time of a programmer “worth”? Is the programmer the analog of the “cost of goods sold”?
if you are not baffled by now, try to think what the services of a trader at a big bank are worth, a guy who has the responsibility for moving billions of dollars in “paper” from counterparty to counterparty. But, as we all know, he “makes” nothing real.
To make matters more complex, in recent years, pricing has increasingly moved from static to dynamic: today homes are sold at auction, used cars are sold on eBay, and all products appear to be sold at a “discount” or “on sale.” Prices are rarely fixed anymore; sometimes they are negotiable.
The final step in complexity is when your product itself is intangible: a social network, big data, an iPhone app to tell you what time the neighborhood movie starts.
For a startup team, especially with an intangible product, it’s tempting to shortcut all this complexity and give the product away. After all, that’s what Twitter and Facebook and Google do.
But that’s a very dangerous model for the long term. If you choose it, it’s highly likely that you will be building a product, but not a business. At some point, you may be able to charge advertisers for access to your audience–or not. At present, Facebook is doing well with advertising, but Twitter is not. Personally, I believe Twitter will have to be sold as a product to a company that can blend it into an already existing business.
Another common model today is “freemium,” in which a certain amount of the product (storage, New York Times articles) or a limited feature set is offered free, but the full product requires payment.
I wish I could tell you the right way to price your product, but I can’t. It’s different in every business. But it does require a great deal of discussion, and probably with an accountant and a marketing advisor. Not every company is Twitter, smack in the middle of San Francisco with VCs climbing all over themselves to invest money and no need to monetize for years. The average great company has to begin selling right away.
When you begin to sell, you should price your product at what the market will bear, and not below just to acquire customers. The race to the bottom can be very fast, and you don’t want to win it.
[Image: Flickr user Allen]