Setting the perfect price for your products or services isn’t easy. With dozens of different pricing methods available to you, an abundance of conflicting advice and an ever-changing marketplace, the options are overwhelming.
It’s nearly impossible to figure out what the optimal price is, and there’s no objective way to conclusively measure it either.
Yet, setting the right price is crucially important for your business. Price optimization is one of the easiest and highest ROI business activities you can engage in.
The sad truth is that most business owners have set their prices with no good underlying rationale. They’ve set their prices at random or blindly copied them from a competitor, and often don’t review their pricing for years on end. Often, they grossly undervalue what their products and services are really worth to their customers, leaving easy money on the table.
By sitting down, thinking about, testing and optimizing your pricing, you can drastically boost your bottom line. By changing a few numbers, you can not only grow your revenue, but also your profits – without doing any extra work.
Are You Using The Right Pricing Strategy?
Not only do many business owners charge a wrong (or suboptimal) price, many of them don’t even use the right pricing strategy to begin with!
The most popular pricing methods you come across online essentially fall under two main pricing strategies:
- Cost-plus pricing: you calculate your cost, add a profit margin on top, and that’s the price you charge.
- Value-based pricing: you estimate the value your customers get out of using your products or services, and charge a portion of that value.
Most business owners start out using cost-plus pricing and never look back. They never even bother to experiment or change it.
While that makes sense for some businesses, it certainly isn’t the best strategy to follow for everyone.
Cost-Plus Pricing Is Simple
Cost-plus pricing is most commonly used because it’s so straightforward: you make a product, calculate how much it costs you to make that product, add a profit margin on top of it and sell it.
For example, if you provide webhosting, you can calculate exactly how much it costs to run your servers and provide your service.
Let’s say it costs you $10 per month for the serverspace and other tools required for one customer. You’d like to make a 25% profit margin on it, so you’ll charge $12.50 per month.
Because it’s so obvious, cost-plus pricing is the most commonly used form of pricing, especially by new business owners.
Although cost-plus pricing is a great fit for some businesses, it certainly isn’t the best one for all of them. Cost-plus pricing has some very significant downsides.
The Problems With Cost-Plus Pricing
1. You might come across additional costs.
Often, your estimated production costs turn out to be incorrect. As any business owner knows, unexpected costs will materialize out of nowhere, and everything turns out to be more expensive than you’ve initially planned.
When you’re operating on a tight profit margin (as is often the case with most cost-plus pricing methods), these additional costs eat directly into your profit margins.
2. It’s a race to the bottom.
Cost-plus based pricing is inherently driven by a mindset where you’re competing on price – not on quality, value, speed or any other differentiator. This line of thinking will often result in a race to the bottom with your competitors.
You undercut your competitors, slightly dropping your profit margin. Another competitor does the same. You undercut them again, lowering your profit margin once again. Eventually, profit margins evaporate, and you will need to cut costs and lower quality to still be competitive. Competing on price should be a last resort, not your first.
3. Customers are not as price-sensitive than you think.
While competing on cost can make a lot of sense if you’re selling a basic raw commodity like oil or salt, odds are that you aren’t.
What you’re selling online usually has more ways to be differentiated on than price alone. And if that’s the case, it’s likely that your customers aren’t all that price sensitive to begin with.
Particularly in B2B settings, customers just don’t care about price as much as you think. What really matters about a tool or service is that it gets the job done, is easy to use, fits within their workflow and as an afterthought, isn’t too expensive.
But lowering or raising your price a few dollars will not attract any of these potential customers, or turn them away either. Your attempts at lowering your price might only lower your profit margin, without attracting additional customers.
4. You might leave massive amounts of money on the table.
Most importantly: cost-based pricing often leaves a lot of money on the table.
Most people believe that getting more customers is better, but this isn’t always the case. Remember, as a business owner, you should focus on increasing your total revenue and profitability.
And increasing your sheer number of customers isn’t always the best way to reach that goal. More customers isn’t always better.
Let’s say you build an online tool, and the net cost for each additional customer you sell it to is $5, max. So, using cost-plus pricing, you decide to sell it for $10 – a nice, whopping 50% profit margin.
If you get 600 sales per month, that’s $6000 in revenue, and $3000 in profit every single month.
Now, let’s say you raise the price to $40, and you see your sales numbers plummet to 150 per month. You might not have as many customers as you had before, but you still have a revenue of $6000 per month, and have just increased your profit to $5250!
Additionally, you have now increased your profit margin from 50% to 87.50%, meaning you can now spend more money marketing your business to acquire new customers.
This example isn’t that uncommon. Many businesses who have chosen their prices arbitrarily based on cost can see huge gains just by optimizing their pricing.
What Really Matters Is The Value You Provide
The alternative to cost-plus pricing is value-based pricing. For many online businesses, it’s a complete gamechanger.
The biggest problem with cost-plus pricing is that you’re leaving easy money on the table. You only receive the amount of money you thought was reasonable to charge, not the amount of money they gladly would’ve paid for your products if if only you would’ve had the guts to ask them for it.
Value-based pricing sets the price based on the value your customer receives from your products or services.
Ultimately, any good business owner or marketer should always look at their offerings from their customers’ perspective.
What do your customers want? How can it help them improve their lives? And most importantly – how much value do they get out of it, and how much are they willing to pay for it?
Everything you do as a business owner is about creating value for your customer. And there’s no shame in charging a portion of the value you create for them in return. Your customers will be more than willing to pay it, since they receive more value out of it themselves.
How Value-Based Pricing Can Boost Your Profitability
Say you’ve created a software tool that costs you $10 to provide to each customer, but saves the business owner you sell it to $500 per month. Using cost plus pricing, you’d charge a mere $20. Using value-based pricing, you could charge $100, and it would still be a no-brainer for your customers, since they still make a $400 profit.
As long as you deliver a positive return on investment, your customers will gladly pay a lot more than your costs of goods sold.
Bottom line: if you’re reading this (and are selling something online), you should probably use value-based pricing.
Differentiate what you offer on value, not price.
Ultimately, your customers only care about how much value you provide them with. Not only is a value-based pricing strategy more lucrative for you, it’s also more in line with what your customer truly wants. When you charge more, you can invest more money in creating higher quality tools, products or services that would provide more value to your customers.
Step one to optimize your pricing is to start using a value based pricing strategy.
Step Two: Pick Your Pricing Method
Now that you know how you’ll calculate the height of your prices, you need to decide how you’ll actually charge them.
You can choose different billing models, that sometimes overlap.
Here are the three most common ones:
The most straightforward billing model is the one-time purchase.
Your customers pay the full fee for your product or service in one transaction – whether it’s beforehand or afterwards. You can charge by the hour, by the project or have a set price. What matters is that it’s a one-time transaction you need to sell once.
- Selling a book on Amazon.
- Designing a website.
- Customers are used to this billing model, and often expect it.
- Customers are not suspicious about it at all, because it’s the norm.
- That makes it easier to sell.
- You only make money on each sale once.
- For any followup sales, you need to get in touch with your customer again, and persuade them to buy your product or service again.
- As a result of that, you might leave a lot of money on the table.
One of the most interesting billing models is the subscription or recurring model.
You sell your product or service once, and your customer agrees to keep receiving and paying for it multiple times. This can either be for a set number of times, or continue on indefinitely.
- A gym membership
- An online SaaS tool like Zapier.
- You only have to persuade your customers to buy your product or service once, and you get paid many times.
- Customers might keep a subscription going for a long time because they are used to it, forget about it, or think they’ll use it again soon, earning you a steady ongoing paycheck with low costs.
- If you can pull it off, a subscription model is one of the best billing models you can use.
- You need to have a business model that provides value on an ongoing basis – for months or years.
- It can be difficult to make it work.
Commission Or Usage Based
Another commonly used billing model is based on commission or usage.
Instead of charging a flat fee, you calculate how much people actually use your tools or services, or how much revenue it generates them and charge based off of that.
By definition this model is usually value-based.
- A mailing provider (like Mailchimp) that charges you based on how many emails you send.
- PayPal that charges you a fee on each transaction you send or receive.
- Affiliates that charge a commission for each of your products they sell for you.
- It’s extremely fair: people pay exactly for what they use or how much value they get out of it.
- You’re guaranteed to be paid fairly and can calculate a profit margin in a very straightforward manner.
- It’s a win-win situation for both parties, because you provide value to users, and only charge a portion of that.
- It’s likely to be an ongoing, profitable collaboration because you both benefit from it.
- It can be very hard to actually measure the usage or revenue accurately.
- Most businesses don’t have the control to track and implement this.
Which Pricing And Billing Methods Are Right For You?
It’s not easy to decide which pricing and billing methods are right for you.
There’s no objectively best type of pricing or billing that works for every type of business. It all depends on your specific situation.
Some things to consider when deciding which strategies are right to use are:
- What is your product or service offering?
- How much value are you actually delivering to your customers? (Are you offering a commodity, or a clearly differentiated product or service?)
- What’s the norm in the industry, and what are your competitors doing?
- What fits your personality, your company and your culture?
- What fits your branding and your marketing?
Whatever your situation is, know that you have multiple types of pricing and billing that you can choose from.
There’s no one-size fits all, but in most cases, you’re not resigned to one specific type of pricing either.
Many industries previously thought to be set in stone have been disrupted and reinvented by smart newcomers with a new pricing model.
You too could try out different pricing options and see which one works best for your business.
Pricing Tables Made Easy
Once you’ve set your prices, you need to display them on your website. If you’re running a WordPress website, the easiest way to do that is with our Easy Pricing Tables plugin.
The design of your pricing page has a huge impact on your online sales. But creating a pricing table that looks good AND converts on your own can be very hard.
Easy Pricing Tables for WordPress makes this super easy. Create a gorgeous pricing table that sells, and connect it to your favorite shopping cart service in just a few simple steps. You’ll get a fully customizable, mobile responsive pricing table that looks great on all devices.