Entrepreneurs should determine how much customers are prepared to spend on their products. But they must also make sure they cover their costs.
Finding a fair price for your product is about striking the right balance. The price should reflect the amount invested to produce the product, the profit margin you want to make and also the state of the market (supply and demand). There are two ways of doing this:
- Cost price. This is the price a product should cost so that manufacturing costs are covered. It includes actual costs, overheads, administrative expenses (secretary’s office, reception), energy costs (water, electricity), rent, telephone, insurance, office items, vehicles, advertising, equipment maintenance, tax advisor, accounting, etc.
- Current price or market price. This is the price customers are prepared to pay. Here, the supply-demand ratio plays a key role: if a product or service is rare, but also in demand, you can fix the price at a much higher level than if it is a common product or a product which is not very much in demand.
Ideally, you should find an average between the cost price and the current price which is as close as possible to the latter. If this is not possible, for example, because the entrepreneur’s costs are too high, one of the following adjustments may be made:
- aim at a different target audience
- reduce your costs
- use additional advertising to increase the size of your target market and make economies of scale
- improve your offering so that you are able to set higher prices
A company often ends up being associated with its price policy, which becomes part of its identity. The supermarket chain Aldi is intrinsically linked to its low prices, just as the luxury brands Chanel and BMW have an image of being expensive. But whichever price range is chosen, it must be perceived as “fair” by the customer.
Traditionally, the price is determined by an accounting approach, adding up the costs of production to the desired margin. Now, the value-based approach to marketing is gaining popularity:
- Cost to design: This method sets the price by multiplying the manufacturing cost by a predetermined coefficient, depending on the positioning of the product. The price, therefore, depends only on costs and the desired margin. For example, a restaurateur applying a coefficient of 3 will sell a bottle purchased for 9 francs for 27 francs. However, the method is not appropriate for certain products and services because it would make them expensive and virtually unsaleable;
- Design to cost: This method involves optimising the cost of a product from the design stage. The company sets a target price that is considered acceptable and subtracts the margin to obtain the targeted costs. This approach makes cost a price-dependent variable, allowing for proactive pricing that focuses on customer-perceived value.
By adopting the design-to-cost method, companies set more competitive prices that better reflect customer expectations. This approach can lead to a better market acceptance of the product or service.
To determine the price perceived as fair by customers, you may question a representative sample of potential customers by asking them two questions:
- What is the maximum price above which they would not purchase the product or service?
- What is the minimum price below which they would not buy it either? Indeed, the minimum price is crucial because if the product or service is sold too cheap, it risks being discredited in the eyes of the customer. By directly consulting the target customer, the company can establish an acceptable price consistent with the quality of the product or service.
Visual organization of prices
The way you display your prices can have a decisive impact on the buying act. A product sells better at CHF 499 than at CHF 500. It is also worth offering a 50% discount on the second pair of shoes purchased rather than 25% when buying two pairs. It can also be more effective to mark discounts in absolute figures rather than as a percentage.
