Thursday, August 25, 2005

How to price a new product

One question I often hear is "how do I price my new product?" Assuming a goal of maximizing profit, how can you determine the optimal price to set? This is always an interesting question, and not an easy one to answer.

For B2B products, there are some guidelines that I would follow.

1) Determine what does it cost you to make your product. Many people use this as the basis for determining their price (take this cost and add some percentage to give you a profit margin). This works in that it could give you a profitable product, but this is probably not the optimal profit-giving price. Instead, I recommend that you mostly use your cost just to determine if the price you are selling at is one that justifies making the product. This is the lowest price that you should accept and still be able to have a viable business.

2) Also determine what is the benefit of using your product to the customer. What does it cost them to do what they are doing now to get their need solved, versus what it would cost them with your product. The difference is the benefit to them.
You will likely have to estimate this, as getting accurate data is a challenge. This is the highest price that a customer may pay before the economics say they shouldn't buy your product.

3) the price you set should be somewhere between your cost and their benefit. Choosing the price between these is definitely more of an art than science. On the whole, you want to choose a price as compared to them not using a product like yours that allows them to have a return on their investment of a year or less (e.g. if price for your product is $50,000, make sure they get at least that much benefit within a year from using your product).

Competitive product's prices also play here - if a competitor makes a product that does the same thing as yours, this often should be used as a baseline for your pricing. You would then adjust your price, depending on whether you are trying to be the cost leader (adjust your price down), quality leader (adjust your price up), if there are features which the customer wants that you have which the competitor doesn't (adjust your price up), etc.

For B2C products, I think a much more supply-demand type look needs to be done. In most B2B, you usually have a smaller number of customers who spend more to buy the product, so you can calculate a benefit for the purchaser. But in B2C, there are usually so many purchasers through different channels (who set there own pricing based on your suggestions) that this doesn't work. Instead you probably want to do test pricing (adjusting a price and then seeing its impact on sales) until you find the one which gives you the best profitability.

Setting a price for your product can seem like a daunting task, but by thinking through a few things, you can come up with a pricing scheme that improves the profitability of your company.


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