The Four Pricing Methods Of Setting Price
One of the most difficult things an entrepreneur will face/has faced is “pricing method” Sometimes you are confronted with what pricing strategy to adopt. You don’t want to over-charge and lose customer neither are you willing to under-charge and run at a loss. This was a thorn in my skin year’s back until I grew above it. So, I perfectly understand the feeling.
Before I go over to explaining the four pricing principles, let’s make a little bit of assumption.
Here is it:
Assume for a moment that you own a house and you want to sell that house. Remember you are to sell this house yourself. According to the Price Uncertainty Principle, the price of a product could be anything, (any amount). So, let’s also presume that you would prefer to sell the house for as any amount as possible. How would you set the price that a client will accept and is willing to pay for?
Away from the assumption, you should be tactic with your pricing method. Before you put a price tag on a product or service, consider what your competitor is doing as well.
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Here are the four remarkable ways to cost/tag a price on a product.
So, without much ado, let’s look at them one after another.
The Four Pricing Methods Of Setting Price
1. The Replacement Cost method
This method supports a price by answering the question “How much would it cost to replace?” In the case of the house, the question becomes “What would it cost to create or construct a house just like this one?”
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Assume a meteorite hit on the house, and there is nothing left and you have to rebuild the house from scratch again. What would it take to purchase similar land, pay for an architect to draw up plans, acquire identical materials, and hire construction workers to create exactly the same house? Total up these costs; add a bit of margin to compensate for your time and effort, and you will have a supportable estimate of how much your house is worth.
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Replacement Cost is typically a “cost-plus” calculation: figure out how much it costs to create, add your desired markup, and set your price appropriately.
2. The Market Comparison method
This pricing method is used for pricing a product by answering the question “How much are other things like this selling for?” In the case of the house, this question becomes “How much have houses like this, in this general area, sold for recently?”
If you look at the surrounding area, there are probably a few other houses similar to the one you own that have been sold within the past year. They are probably not exactly the same (maybe they have an extra bedroom or bathroom, etc.) but they are close enough. After you adjust for the differences, you can use the sale prices of those “comparable” houses to create a supportable estimate of how much your house is worth.
Market Comparison is a very common way to price offers: find a similar product and set your price relatively close to what they are asking.
3. The Discounted Cash Flow (DCF) / Net Present Value (NPV) method
This method supports a price by answering the question “How much is it worth if it can bring in money over time?” Still with your house, the question becomes “How much would this house bring in each month if you rented it for a period of time, and how much is that series of cash flows worth as a lump sum today?”
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Rent payments come in every month, which is quite handy: you can use the DCF/NPV formulas to calculate what that series of payments over a certain period of time would be worth if you received it in one lump sum.
By calculating the NPV of the house assuming you could rent it for N10, 000 a month for a period of ten years with 95 percent occupancy and you could earn 7 percent interest on your money by choosing the Next Best Alternative, you will have a supportable estimate of what the house is worth.
DCF/NPV is only used for pricing things that can produce an ongoing cash flow, which makes it a very common way to price businesses when they are sold or acquired—the more profit the business generates each month, the more valuable the business is to the purchaser.
4. The Value Comparison method
This pricing method supports a price by answering the question “Who is this particularly valuable to?”
In the case of the house, this question becomes “What features of this house would make it valuable to certain types of people?”
Let’s assume the house is in an attractive, safe neighborhood with a top-tier school nearby. These characteristics would make the house more valuable to families who have school-age children, particularly if they want to attend that school. To potential homebuyers in the market, this particular house would be more valuable than the same house in an area with inferior schools.
This is the pricing method used by estate management companies.
By looking at the unique characteristics of what you are offering and the corresponding worth of those characteristics to certain individuals, you can often hype the price.
Value Comparison is typically the optimal way to price your product, since the value of an offer to a specific group can be quite high, resulting in a much better price. Use the other methods as a baseline, but focus on discovering how much your offer is worth to the party you hope to sell it to, and then set your price appropriately.
Conclusively, follow these pricing methods and analyze whether your current price is in the right direction or need a change to increase sale.