How much revenue is your pricing strategy leaving on the table?
This is a major point of confusion for many business owners, and if priced incorrectly, can cost thousands of dollars in lost revenue each year. Are you pricing your product for optimal conversion? Let's find out!
Whether you sell a product, service, or work as a consultant, there are dozens of pricing strategies to choose from. To save you time, money and endless headaches here is the 3-step process to pricing your product for maximum revenue.
1) Price based on benefit, not cost
When deciding how much to charge, focus on the benefit to the customer rather than the cost of production.
This is a common mistake among early entrepreneurs, “It costs me $9.25 per unit to manufacture so I’ll use a markup multiple, (i.e. 10x), and charge $92.50/unit.”
If you're a consultant, it might sound something like, "I made $70,000/year at my last job, so I'll divide $70k by 2,080 working hours in a year and charge $34/hour."
If you can avoid these two common mistakes you'll be miles ahead of the competition!
In the first example, yes, you want to aim for a minimum 10x markup, but it’s more important to think of the value your product provides to the customer.
For an independent consultant, you now have to pay for health benefits, office supplies, vacation time, and build a pension. $34/hour simply won't cut it.
Always ask yourself: What benefit will the customer receive, and how much is that worth?
For example, a software company may create a human resources application that will save customers $10,000/year in recruitment costs by streamlining the recruiting process, yet they charge only $500 for the software package.
By saving the client $10,000/year, the software company could easily charge $1,000 while still delivering a major value to the client.
If you're a consultant and charging by the hour, a good rule of thumb is to take your hourly rate (as calculated above) and double it. However, you can make even more money if you charge per project, rather than hourly.
When first starting out, charging by the hour is a great way to familiarize yourself with the industry and gauge the amount of time it takes you to complete a particular job.
Once you’ve become accustomed to the market and the types of projects you’ll be completing, it’s best to shift to a project-based pricing strategy, i.e. charge clients based on the value of the results you provide.
Keeping with the HR theme: if you’re an HR consultant who knows you can save a company 20% on their recruitment costs, and this works out to $20,000 in savings to their bottom line, you can, therefore, price yourself accordingly.
A good rule of thumb when establishing project-based pricing is to deliver 10x what you charge. So, if you’re going to save them $20,000 in recruitment costs this means you should charge a minimum project fee of $2,000 (10% of $20,000).
It’s important, however, not to set your price too low. The last thing you want is to work way more hours than you’ve priced.
Once again, stick to the hourly price model until you can predict with near certainty the amount of time and effort required to complete a particular project.
"My pricing seems too high, I feel guilty charging so much!"
Pricing yourself based on value and benefit will no doubt bring forth complaints that your price is too high. This is simply the reality of the business world.
It’s tempting to take the low hanging fruit and discount your price to make the sale, but don’t let a few one-off customers convince you to lower your rates.
As I explain in my article, Want to Increase Sales? Start Doing These Three Things, discounting only leads to a slippery slope that can quickly destroy your business.
Unless you’re Walmart or Amazon, and can successfully compete with a competitive pricing strategy, there’s almost always someone else out there willing to cut their margins a little bit more in order to beat your price. This will only lead to a price battle that will inevitably leave you both bankrupt.
Compete based on value, not price. If a customer complains about your price they simply aren’t the optimal customer for you. Ultimately, the market will decide if your pricing it too expensive; simply, listen to the masses.
Furthermore, anyone unable to see the benefit, and who complains about price is an early indication of a high-maintenance customer and will likely only create more headaches down the road. Avoid whiners; focus on those who see and understand your value.
2) Once pricing is set, time to maximize profit
Having one single price is a rookie move! To maximize profitability you should always try to offer more than one price for your product or service.
I’m talking about pricing tiers, and they have several HUGE benefits:
- Multiple pricing tiers let you increase income without having to increase your customer base (i.e. up-sell current customers);
- Numerous tiers expand your reach to a wider audience with various budget amounts;
- Having multiple tiers “anchor” people into paying more (more about this below);
- Pricing tiers drive more qualified leads by getting people in the door at the lowest possible entry point before gradually moving them up the price ladder.
The key to success with a tiered pricing strategy is to offer a limited range of prices so not to confuse prospective customers.
Keep it incredibly clear and simple; aim for a minimum of 3 tiers, but never more than 5.
There’s also a major psychological effect at play when using pricing tiers. Rather than asking prospective customers if they would like to buy your product, you're now asking them which product they’d like to buy.
Pricing tiers establish the perception in the mind of the prospect that they will make a purchase but simply don’t yet know which one.
An example of tiered pricing:
Start with the basic features that will be included in each tier, and whether or not you want to offer them for free.
As you get more familiar with your customers needs these base features will become increasingly obvious. In the meantime, it’s OK to experiment and test various features and price levels.
As your price tiers increase, think about the type of customer that will fall into each level; the needs of a small local business greatly differ from that of a Fortune 500 company.
Include additional features and benefits based on the needs of each customer group, increasing the scope and complexity of the features as each tier caters to a larger and more sophisticated client.
Regardless of size, some customers may always choose the most expensive option. This is the cherry on top that will increase your overall selling price.
Once you've outlined the features, use an anchor to set the price for each tier.
When setting the price for each tier, the most important tier to focus on is that which is most expensive. Even though this tier may convert the fewest number of customers, it sets the stage for the success of all other tiers. Apple, for example, uses this strategy in every product launch.
Providing an exclusive, high-end version creates what is known as an anchor price. Essentially, when we see a ridiculously high price tag we tend to think of the lesser expensive option as far more reasonable; perhaps even a bargain.
Apple, for example, recently released their most expensive iPhone ever, the iPhone X, at a staggering price of $1,500!
But, they also released the lesser expensive iPhone 8 and iPhone 8 Plus, ranging from $900 - $1,200. They even go a step further and offer additional price tiers within each product category, but the strategy remains the same.
Some people will always opt for the most expensive option, but for the majority of consumers the sticker shock of $1,500 makes the $900 model look like a deal!
Let’s do the math, using iPhone as an example and assuming 100 total sales in each scenario:
As you can see, the use of tiered pricing increased the average income per sale, producing an additional $12,000, or nearly 14% to the bottom line!
As we’ve learned, the bulk of customers will likely go with the least expensive option, but it’s the existence of higher-priced tiers that justify the act of making a purchase in the first place.
In the consumer's mind, $900 looks like a deal compared to $1,500, and although we anchor our pricing model on the highest tier, the strategy and focus is to get more overall customers into the lowest tier. The gravy on top is those who want the biggest and best option and opt for the $1,500 model.
Finally, by offering multiple price levels that cater to various customer groups, Apple doesn’t have to compete with its competitors on price (something I discuss in-depth in Want to Increase Sales? Start Doing These Three Things).
3) Get paid multiple times
The final piece of the pricing puzzle is to avoid getting paid only once (if you can). What I’m referring to is some type of subscription or membership program.
Why get paid a single time when you can get paid on a recurring basis from the same customer?
Providing a regularly delivered product or service coupled with a recurring revenue model will almost always generate far more income over time than a single-sale product.
Recurring revenue also provides peace of mind by allowing you to estimate future revenue, which in turn gives you more capital to develop new products or make investments into your business without worrying about your next sale.
Lastly, the recurring revenue model is incredibly easy to scale and optimize, which means monumental gains to your revenue goals.
For example, assuming you have 100 customers each paying $10/month, there are two factors you can now tweak that will result in massive revenue gains: the number of subscribers, AND the monthly price.
Getting more subscribers is self-explanatory, but increasing your monthly price can grow revenue exponentially – (increase price across the board, or by grandfathering-in higher rates with new customers).
Let’s do the math for each scenario, assuming we start the year with 100 existing customers and acquire 100 new customers throughout the year:
As you can see, focusing on customer acquisition AND pricing can drastically increase overall revenue.
In the beginning, you might keep your prices steady, but as your business grows and you begin offering more value to your customers, don’t be afraid to raise your rates accordingly.
With tiered pricing, you must also focus on moving customers up the ladder from the lower tiers. Remember, the anchor price is simply meant to get customers in the door at the lowest possible price. Once they're in, however, the real work begins.
As your relationship with each customer grows it will get easier to move them up the ladder, gaining an increased share of their budget (i.e. up-selling existing customers).
Key Takeaway: It's crucial to ensure customers understand the value that you help create, whether you’re saving them money, time, solving their problems, or delivering results. Everything has a value, but not everyone realizes it until someone points it out.
Break down client goals into measurable performance indicators so that you can quantify results and set targets for success.
Start small. As you get better at quantifying your value you’ll feel more comfortable raising your prices.
Don’t be afraid to experiment with various price tiers and benefits; trial and error is the only way to find the optimal balance.