Let’s say you’re thinking of selling cupcakes at a local market this summer. How should you price them? You have a few options…
Option 1: Calculate
How much do your ingredients cost? Add up the flour, the sugar, the butter, etc. Can you reduce those prices by buying in bulk? Suppose the ingredients in one cupcake cost $0.20. Then you add the cost of packaging and labels, which are $0.05 per cupcake. And we can’t forget the cupcakes you’ll cut up to give away as free samples, which adds another $0.08 of sunk cost per sold cupcake.
Those are just the variable costs. You’ll also have fixed costs as well, like event fees. The market charges $40 for a booth for the day, and you expect to sell about 250 cupcakes, or $0.16 per cupcake. Your temporary event permit costs $20, or $0.08 per cupcake, which brings the total amount to $0.57 per cupcake.
You’ll have other fixed costs as well, like your equipment, insurance, CFO permit fee, etc. You have to figure out how much you’ll sell over the lifetime of those items and divvy up those expenses accordingly. Plus you want to pay yourself $20/hour, not only for the time you spent making the cupcakes, but also the time spent at the market. You finally add all the amounts together and arrive at a final price of $1.25 per cupcake, or $15 per dozen.
Option 2: Compare
You recently visited a local cupcakery, which had a dazzling array of cupcakes and flavors, each of which looked more tempting than the next. You recall paying $3 for one of those cupcakes, so… that must be the going price in this town, right? But then you remember that they’re a well-established company with a recognizable brand name, a strong customer base, and a physical store, so you probably can’t sell at the same prices that they can. Maybe you could get away with $2 per cupcake? Maybe people would even start preferring you over them based on price alone.
Then you recall the cupcakes in the grocery store, priced at $6/dozen, or $0.50 per cupcake. They also have a brand name, customer base, and store, so you’re not so sure about the $2 price point anymore. Granted, their cupcakes aren’t as fresh or good as yours (they were probably made by a robot), but are yours really four times as good? Can you justify charging quadruple what the grocery store does?
No no no… stop thinking that way! I know it’s tempting to think about how much money and time it took to make your goods, and it’s especially tempting to want to beat your competition’s price, but fixating on these things is a recipe for disaster.
The key word is “fixating”. I’m not suggesting that you abandon that info entirely. Being aware of your variable and fixed costs allows you to know whether you’re operating at a profit or loss, which is important for any business. Being aware of other cupcake prices in the market allows you to gauge the general perceived value of cupcakes in your area.
However, often the “calculate” and “compare” pricing methods can get you bogged down in math or endless debating, and they disregard the most important factor in determining a price…
Option 3: Create
Years ago, my grandpa explained pricing very simply to me: “Something is only worth what someone else is willing to pay for it.” I think he often reminded me of that at yard sales, when other people were only willing to pay far, far less for an item than I thought they should.
My grandpa was right, but that still doesn’t answer the ultimate question: “How do you determine what someone else is willing to pay?” My grandpa left me to discover a strange fact on my own: the product itself has surprisingly little to do with the price, and it is actually the seller that has the most influence in determining what something is worth.
But you don’t have to take my word for it. Just ask Joshua Bell, the famous American violinist who played for tips in the Washington DC metro as part of an experiment by the Washington Post. Three days earlier, he played his $3.5 million violin in Boston’s Symphony Hall, where an average seat price was around $100. So what happened when the same person with the same violin played the same music for 45 minutes to over a thousand passersby in the metro? He mostly went unnoticed, and he made just $32. This is an extreme case, and neither you nor I are a Joshua Bell, but make no mistake about it: positioning matters.
Nowadays I think of it this way: “The price should be based on the perceived value that a product adds to someone else’s life”. I say “perceived” because it doesn’t necessarily need to translate into tangible value for the customer; rather, they only need to believe that it was worth what they paid. And fortunately, you as the seller have great influence on that perception.
To put it more concisely, your product’s worth isn’t based on its ingredients or its competition: it is based on value. You are not selling a cupcake… you are selling an improvement to someone else’s life. If your custom birthday party cupcakes just made a mother look like a superhero (in the eyes of her daughter), that’s real value that likely transcends your asking price. Your job is to position your product in such a way that lets the mother realize that purchasing your cupcakes will be far more valuable to her than buying that $6 dozen at the grocery store.
You have the power to change your product’s positioning, perception, and price. Hopefully you envision your product improving people’s lives; how can you share that vision with them? What end value are you offering, and are you communicating it well? What can you do to increase the value that your products have on customers? When you can price your products based on value, you won’t have to price them based on “cost of goods” or competition anymore.