Learning How to Set The Right Price

This was taken from the Wall Street Journal article discussing different pricing methodologies. It is clear from these excerpts that pricing is very situation specific. One of the key elements in building a successful business is setting the right price for a product or service. Materials, labor cost and overhead should go into the equation, but it's also necessary to think about whether to undercut rivals. If the price is set too low, incoming revenue might not suffice and the venture might struggle to stay afloat. The Wall Street Journal blog The Accelerators asked a group of startup mentors to provide their insights. Edited excerpts:

Price Is Biggest Indicator Of Quality, Said Professor

The four founders of Warby Parker, including me, were students at Wharton [business school of the University of Pennsylvania] when we launched the company. Seeking advice about pricing, we approached our marketing professor, Jagmohan Raju, with a presentation that outlined our strategy. The plan was to sell prescription glasses that typically cost $500 for just $45—and to do so online. Without even glancing at our slides, Professor Raju shook his head. "No way," he said. "It won't work." Selling a product for less than one-tenth of what competitors charge was, he explained, simply outside the realm of believability. No customer would trust that our quality was even comparable, much less equal or better. Price, he reminded us, is the biggest indicator of quality. Plus, our professor added, no matter how carefully we calculated the cost of goods, we should expect that cost to be significantly higher than planned. If we priced too low, our gross margins would be low, leaving us with nothing left for marketing. And he was right. Our cost of goods ended up being more than double what we had initially projected. We also found that customers did not trust prices that were too low. For many of them, $100 was the critical threshold. With all this in mind, we priced our eyeglasses and sunglasses at $95. We wanted to provide exceptional value without necessarily providing a discount. —Neil Blumenthal, co-CEO of Warby Parker, New York

Think About What Kind Of Return Customers Get

As with anything in business, you need to start with a deep understanding of your customers and what they value. You should think about what kind of return your customers will get from using your product and how fast they'll realize a gain. Sometimes you have to break new ground in pricing to become a next-generation leader. When the rental pricing model known as software-as-a-service emerged, it completely disrupted incumbent players who sold licensed software, such as Oracle ORCL +0.15% and IBM IBM +0.05% . The monthly recurring revenue per seat may be relatively small, making it easy to sell, but the strategy can generate significant revenue once a lot of users sign up. Some products and services are most compelling if you never charge a customer directly, but instead use an ad-supported model. The trick is to maintain your site's appeal while also delivering a strong ROI for your advertisers. —Kate Mitchell, venture investor at Scale Venture Partners, San Francisco

Calculating the True Cost; Guess Can Also Be Pricing

The easiest starting point for determining the price for a product or service is by first calculating the cost of delivering the finished good to the end consumer. It's critical to ensure that you are covering your expenses on every sale. Next, ask your potential customers for feedback before making any pricing decisions. You may be surprised to see how many will respond thoughtfully and with realistic pricing suggestions. The final and least scientific method of pricing is through the use of good old-fashioned guessing. If a product or service is new, consumers' expectations haven't yet been set. As long as an entrepreneur has accurately calculated his or her true costs, and therefore knows the bare minimum that he or she can charge, there really is no right or wrong amount of profit margin that should be added. —Kevin Colleran, venture partner at General Catalyst Partners, Cambridge, Mass.

When Zero Is Right Price; Experiment to Find Top

The easiest starting point for determining the price for a product or service is by first calculating the cost of delivering the finished good to the end consumer. It's critical to ensure that you are covering your expenses on every sale. If you're a consumer-facing startup that's social or has a network effect, where each new user adds value to the existing users, then the right price is zero. Anything higher will cause a competitor to come along, scoop up more users and kill you. If you have businesses and consumers using your product, then set the price higher for businesses and business-related features. There are obvious ways of doing this, such as tiered pricing plans. If most of your customers are businesses, then you need to experiment heavily to find the top. An enterprise sales guy once told me how they'd sell product—he'd walk into the meeting and say "It's a thousand dollars… per user… per month… plus maintenance." As long as the customer didn't blink, he would keep pushing the price up. —Naval Ravikant, founder and CEO of AngelList, San Francisco

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