Q: My partner and I are having a hard time coming up with what we feel is the perfect price for our new product. We know what competing products sell for, but we don't know if it's better to price our product cheaper than theirs or charge more because we feel it's a superior product. What is the best way to determine the perfect price, and what is the rule of thumb for raising prices later on?
A: Unfortunately, there is no such thing as the perfect price. There is that mythical price that gives the customer excellent bang for his buck and the company excellent profits for its efforts, but even that price point can't be considered the perfect price. That's called compromise, not perfection.
Pricing is an important aspect of every business because price is used to create financial projections, establish a break-even point, and calculate profit and loss. Though price may be determined by any number of factors, basically there are three ways to establish the price for your product:
1. Perform a comparative analysis on similar products sold by competitors.
Are the features and benefits similar to your product's? If so, use the price of the competing product as a possible price point for your product. If your product is of superior quality, features and benefits, then you might be able to justify a higher price and still be competitive. If your product is inferior, then your price point will be less.
2. Calculate the total cost to produce and deliver your product.
Use this amount to figure in an acceptable margin of profit to calculate the final price.
3. Use what I call "The David Copperfield Method."
Named after the famous magician who made the Statue of Liberty disappear on national TV, this method of pricing simply means that you pull the price out of thin air. Believe it or not, many companies use this method to establish pricing. It's also the reason many companies disappear.
It's easier to understand the allure of the Copperfield Method when you realize that more often than not, product pricing comes down to one thing: perception.
Perception-or, as it is more commonly referred to in business, perceived value-is one factor most entrepreneurs use to determine product pricing. After all, our products are our children. We create them, nurture them, grow them and love them. And often we perceive their value to be much greater than the market perceives it to be.
It's all about the perception of value. What makes a $10,000 Rolex watch more valuable than a $10 Timex? Functionally, both are watches and both perform the exact same function: They tell time. Why then does one sell for a thousand times more than the other? The answer is because it has perceived value.
An expensive wristwatch cannot make you better-looking, smarter, healthier or more popular with the opposite sex. But the perception is that if you have a Rolex on your arm, you must have something going for you that the wearer of a $10 Timex does not.
Establishing a good price point from the beginning is vital, because it's much easier to lower prices than to raise them. If you introduce a product at $100 and make no sales, you can easily lower the price to $75 without attracting much attention. However, if you introduce the product at $75 and it proves popular, and you subsequently raise the price to $100, you may face irate customers and even be accused of price-gouging. So it's better to start high and adjust down, if needed.
There really is no rule of thumb when it comes to raising prices. Prices are never set in stone, and consumers expect them to change with the times. You might raise prices to cover an increase in the cost of manufacturing and other production costs, or in response to market demand (the greater the demand, the higher the price).
You can also justify a price increase when you improve a product's quality, features and benefits. The buying public is generally price-conscious, but if you can show that the value of your product has increased by the addition of new features and benefits, then the public will usually not balk at an increase in price. Keep in mind that price increases should be done in small increments over time, not by significant amounts overnight.
Tim W. Knox is the founder, president and CEO of three successful technology companies: B2Secure Inc., a Web-based hiring management software company; Digital Graphiti Inc., a software development company; and DropshipWholesale.net, an online organization dedicated to helping entrepreneurs launch and prosper from their own eBay or online sales business.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.