If customers don’t care about cost, then why do so many firms put so much emphasis on cost when determining price? The answer is that these same firms who rely on cost to determine prices probably don’t understand the value of the products and services they deliver to customers. And because they don’t understand the value that they deliver, they take the easy way out during pricing discussions and introduce internal costs into the pricing equation. The problem with introducing cost too soon into the pricing discussion is that you end up with a price that is acceptable to your own company, but not necessarily acceptable to the market. Translation: your products and services will typically be underpriced.
Instead, you need to go out and talk to your customer base about the value they receive from your products and services. And don’t talk price, talk value. Find out how much economic gain these customers receive from your offerings. Understand if this value is a one-time occurrence or if it is recurs year after year. And also find out what alternates exist in the marketplace today.
Now don’t get me wrong, internal costs are vitally important in the sense that they help determine whether your selling price will deliver adequate internal margins (Margin = Price – Cost). But cost should only be introduced after the price has been determined; not during the pricing discussion itself. Let me repeat that, introduce cost only after price has been derived. Translation: price should never be a function of cost.
Most firms provide high value to their customers, but very few recognize this value and even fewer are able to quantify this value. Don’t make this same mistake. Get out of the office and talk with your end users. Find out directly from your buyers the value that they receive from your offering. Take that information and use it as the basis for determining price going forward. And as for cost, use it only to calculate whether margins are adequate.
Here’s the takeaway: Don’t introduce cost into your pricing discussion. Use it only after price has been derived in order to verify whether margins are adequate. Bringing cost into the discussion too soon typically results in lower prices and lower profits – money that will never be recovered.
Patrick Lefler is the founder of The Spruance Group – a management consultancy that helps growing companies grow faster. He is a former Marine Corps officer; a graduate of both Annapolis and The Wharton School, and has over twenty years of industry expertise.