Rafi Mohammed

It's All About Value

Posted on November 29th, 2006 (0 Comments)

The number one concept I hope you leave this site with is an understanding that your price should be correlated with how customers value your product.

The problem for most businesses is that they use cost plus pricing (e.g., setting prices that are double their costs). While easy to implement, pricing in this manner leaves a bevy of hidden profits. Few of us think when we are buying a product: "the maximum price I"m willing to pay is double what it costs the manufacturer to make it." If you order your steak at a fancy restaurant cooked "medium rare," and it is served to you "well done" – are you willing to pay more because it cost more (more cooking time)? Why are people paying $250 for a Boston Red Sox World Series ticket stub? The price you are willing to pay is all about the value you place on your product.

This notion of value pricing is illustrated in a simple story on this site (Pricing Explained: Concept 1) and my book about street vendors in Washington, DC. These savvy street vendors price in a manner that every company in the world can benefit from. One item these vendors sell is compact umbrellas. What"s interesting is at the first hint of rain, these street vendors double the price of their umbrellas. Why do they do this? To better capture the increased value customers place on an umbrella.

Some businesses do incorporate value into their pricing. Caribbean resorts increase prices during winter holiday weeks to capture that higher value customers place on going to the Caribbean during the frigid cold. These same resorts discount their rooms by 50% or more during the summer when tourists have a lower value of taking a sunny beach vacation. Roses are priced higher on Mothers and Valentine"s Day. Ice cream is discounted during the winter. The latest fashion is priced higher at the beginning of the season and discounted at the end of the season. Price should be used to capture the fluctuating value that customers place on your product.

Here"s a fact: if you are using cost plus pricing, you have hidden profits. When I was writing my book, George, a good friend of mine, joked that I find the professor that first advocated cost plus pricing and figure out how many trillion dollars of profits were lost from this professor"s advice.

The good news is that with a few simple changes of incorporating value in the way you think about pricing, you can start reaping these hidden profits almost immediately.

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