Price is not a function of cost
This is in response to, or to add to, Annette Clancy’s post “Costing and Pricing” about an exercise with artists.
But first, I enjoyed Jeff Nolan’s presentation on “Emerging Trends in Pricing & ROI” at the IT@Cork conference recently.
What is the relationship between how we price our product or service and what it costs us to deliver?
To point out the obvious: Price – Cost = Profit
So which is most appropriate for calculating the cost of your product or service?
1) Price = Cost + Margin (where Margin is % profit you decide to earn on each sale)
2) Price = The perceived value to the buyer adjusted according to competitive forces
3) Price = X% of Return on Investment – where X% might represent one year’s savings as a result of your offering
While agreeing with some of what you put forward – I disagree that price is not a function of cost. Of course it is – it has to be – because if cost is greater than price – you really don’t have any long term viability. I fully accept that it is not just about sticking a margin on top of it but cost has to be a major component of your price as well as being the starting point.
But of course this then leads to a much more complicated discussion of intangible costs where it is not so easy to measure, or indeed more service type businesses where the cost is time and other foregone opportunities i.e. opportunity cost as per your previous post!
food for thought?
The customer shouldn’t care how much it cost you to deliver and only concern themselves with the fact that you will deliver and what value they will get.
If you can’t deliver at the Price the customer offered to pay, then they may need to review what they are willing to pay or do business elsewhere.
To develop long term buyer-supplyier relationships then financial viability of the deal for both parties is important.
B2B – we will make decisions based on ROI with quality and risk in mind, not the cost of producing the goods or service. We will always try and improve our ROI and reduce our risks.
Price isn’t a function of cost but it’s relational to it from the perspective of the maker. I agree that you shouldn’t punish the customer for the angst of making your product but if you don’t know how much it costs to make something you are missing a criticical piece of information in terms of pricing. If you choose to “sell” your work below cost value (which most artists do) then making up the deficit needs to be done elsewhere. Similarly many artists underprice their work because they only do a basic analysis and fail to take into account the ephemeral issues related to price – status of artist, originality, etc etc – it’s nothing to do with the customer and everything to do with the artist.
For a Maidsfield client who was selling a luxury item, effectively an art item, I spoke to 10 of their customers to get an fuller understanding of the value of their product. I felt also that they were undervaluing their product.
I asked each of them if they would pay three times as much. 9 out of 10 said they would.
It’s about value. When you are establishing your selling price, you should factor in the value that you give compared to your competitors. Is your delivery, your availability, your sales team and your product better? You should ensure that your cost is low enough to provide your minimum margin requirement, but don’t mark-up without assessing the optimum price. You may be interested to have a look at http://price-it-right.blogspot.com/.