Let me say it one more time: Customers don’t care about your stinking costs. They really don’t. So if customers don’t care about cost, why do so many firms today put so much emphasis on cost when determining price?
It’s because these same firms don’t really understand the value of the products and services they provide to their customers. And because they don’t fully understand the value, they have no other alternative but to rely on internal costs when determining price.
Pricing discussions are supposed to be tough. They require a thorough analysis of the market and how customers view your products and services—and the information extracted from these discussions is often abstract and imprecise. But just the same, it’s necessary.
So when do you introduce internal costs into the pricing discussion? At some point it has to come up—otherwise you’ll never know whether you’re selling will be profitable. Right? The answer is that internal costs should be introduced AFTER the selling price has been derived.
Here’s a great exercise for anyone having to go through the process of pricing a new product or service. It comes from William Davidow, author of Marketing High Technology: An Insider’s View.
When a marketing department [or the department with ultimate pricing responsibility] is given cost information about a product, it will tend to rely heavily on that information in determining the value of the product to a customer. I’ve long believed that the first pass at pricing a product should be made without the foreknowledge of what the product will cost to manufacture. When a marketing department knows the cost and the margin acceptable to a company, it will use that data to determine a price acceptable to the company rather than to the market.
That is a lazy and naive approach. If you are interested in finding out if your company is guilty of pricing by computation, try this experiment. Deprive your marketing department of cost information during a pricing exercise and see how much agony it produces in the group. The experiment will quickly bring the problem to the surface.
This is an excellent exercise to go through—and perhaps one that should be the norm for most all pricing discussions. When initial pricing decisions are tainted by the knowledge of internal cost information, that same information acts as a psychological anchor to prices—and it’s this “cost anchor” that results in money being left on the table because of an inability to separate price from cost.
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, as margin equals price minus cost. But cost should only be introduced after the price has been determined, not during the pricing discussion itself. Let me repeat myself: Costs should only be introduced after the selling price has been derived. Translation: Price should never be a function of cost.
Most firms provide high value to their customers, but very few firms 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, then take that information and use it as the basis for determining your price going forward. Still concerned about cost? Use it only to calculate whether margins are acceptable.
