Price right!

Pricing a product or service accurately is often more complex than it appears. Many startups assume that undercutting their competitors will automatically attract more customers, but this assumption overlooks some key considerations:

1. What is the true cost of producing and selling the product or service?

To determine the right price, it’s crucial to first understand the total cost of bringing a product or service to market. This involves not only the cost of raw materials or the product itself but also the expenses related to production, packaging, and marketing.

Let’s consider a simple example: A vendor sells tomatoes at a busy taxi rank. He buys boxes of tomatoes from a wholesaler, repackages them into smaller bags of six tomatoes each, and sells these to passersby.

• Tomato costs: 1 box of 60 tomatoes = R120 (R2 per tomato, or R12 for six tomatoes)
• Packaging costs: 10 plastic bags = 10c per bag

The vendor’s cost per bag of six tomatoes is R12.10. His competitors at the taxi rank are selling at R16.50 per bag, so he decides to set his price at R15 per bag, giving him a gross profit of R2.90 per bag.

However, his overall costs go beyond just the tomatoes and bags. He must also cover his time, any signs he uses for marketing, his transport costs, a hawker’s license, and other incidental expenses. At R15 per bag, will he still have enough to cover these additional costs, earn a profit, and afford new stock for the next day? If he doesn’t, he risks not having the funds to continue his business.

2. How does the customer perceive value?

Customer perception isn’t always based on strict logic. When deciding on a price, there are generally three options:

1. Price lower than competitors.
2. Price the same as competitors.
3. Price higher than competitors.

Understanding your target market will help you decide which approach aligns best with their expectations. Some customers prioritise cost, while others are willing to pay a premium for quality, service, or convenience. For instance, someone at a taxi rank might expect a lower price for tomatoes compared to what they would pay in an upscale supermarket.

Before setting your price, consider what factors are most likely to influence your target audience's perception of value. Investors and financial institutions will also expect to see detailed pricing calculations and financial forecasts to ensure your business model is viable.