Let’s define cost as the sum total of the fixed and variable expenses to manufacture or offer your product or service. Every business has both fixed and variable expenses. Fixed costs include rent, utilities, office equipment, insurance, executive salaries, depreciation and property taxes. Variable costs are expenses that vary with the amount of goods produced or service provided. They include the cost of raw materials, hourly wages paid to labourers and contractors, warehouse and shipping costs and sales commissions. Variable costs can also comprise advertising and promotion expenses. By adding your fixed and variable expenses to the per unit profit you desire, you’ll arrive at your cost to offer your product or service. This cost is your floor.
In order to stay in business, you must set prices above the floor. Your ceiling is the customer’s perceived value. In other words, the maximum price customers will pay is based upon what the product is worth to them. Perceived value is a mixture of an established reputation, marketing mix, packaging, competitive atmosphere etc.
The best price for your product lies between the floor and the ceiling. It is important to be aware of costs in establishing prices, but not to get stuck offering only cost-based pricing. Value-based pricing encourages you to evaluate your product and its price from the customer’s perspective.
The break-even point
Whatever your pricing strategy, it’s crucial to know the break-even point. Begin by adding up all fixed costs and determine what your variable costs are at different production volumes. After you’ve determined your break-even points which establish “floors” for your price, there are strategies for establishing pricing based upon additional financial objectives. These include setting a high price to make high profits initially, and setting prices to meet a desired profit goal.
If you understand the customer’s perception of the value of your product or service, you’ll be less likely to price it out of the market. Access customers’ individual preferences and their perception of product features and benefits, convenience, quality, company image, and competitive products.
- The writer is the Father of Guerrilla Marketing and author of Guerrilla Marketing series of books. The views expressed are his own
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