The most experienced entrepreneurs know that price is the dominant factor driving profit. While profits can be increased via a number of ways, raising prices is the simplest method that yields the biggest result. A mere 1 percent change in price can generate double digits change in net profit percentages.
In a study published by McKinsey & Company of the Global 1200, and in the words of Rafi Mohammed, author of the book The 1% Windfall: How Successful Companies Use Price to Profit and Grow, it was found that “if companies increased prices by just 1 percent, and demand remained constant, on average operating profits would increase by 11 percent. Using a 1 percent increase in price, some companies would see even more growth in percentage of profit: Sears, 155 percent; McKesson, 100 percent, Tyson, 81 percent, Land O’Lakes, 58 percent, Whirlpool, 35 percent.”
If pricing is so important, certainly it’d make sense for entrepreneurs to put some serious effort into it, right? Unfortunately, most entrepreneurs skimp out on this opportunity and simply look around to see what everyone else is charging and set their own prices to fit within reasons of the norm. Big mistake. Tim Williams, one of my early career influencers, would say “pricing is positioning,” and they’ve just wasted a perfect opportunity.
So how should we go about pricing then? Here are three questions to help you get on the right path:
What Problem Are You Solving?
Value, like beauty, is in the eye of the beholder.
My buddy Brian and I were chatting the other day and agreed that figuring out what problem you are trying to solve should be top of mind for all entrepreneurs. The problem and the pain that it’s causing your audience would be the main component in calculating how much you can charge for your solution.
When most entrepreneurs are busy figuring out their costs and trying to guess what they should charge, the right thing to do would be to go to the source and understand the value you are creating. Remember, everyone only cares about themselves, and your customers don’t care about your costs and hours spent on the solution. They care about the problem you are solving for them.
Who Are Your Customers?
A continuation of “What problem are you trying to solve?” would be “Who are you solving the problem for?”
The person that you are solving the problem for, how much value they place on this problem going away, as well as how much money they can actually afford will determine what price you can set. While many entrepreneurs would like to think their products or services are worth X and that they are in a vacuumed market of their own, they are wrong. You cannot charge more than the market will bear and that is just one of the few rules everyone has to abide by.
While a small island in the Pacific might be on sale for the low price of $80 million this holiday season, I am not the right buyer for it no matter how it’s priced. I am the wrong audience because I just can’t afford it, even if I really wanted the island.
What Do You Stand For?
While we would like to think that our frontal lobe makes us adults capable of rational decisions, we are not. If anything, scientists have proven that we are predictably irrational when it comes to most things in life. People are driven by emotions, so it is important that your brand speaks to them as such, and there is real value here that people would pay extra for.
If you think your product or service is a commodity where branding and emotions don’t apply, take a walk down the water aisle next time you are at your supermarket. There, you will find one of the best examples of branding’s effect on price. Products like reusable grocery bags and recycled tableware are other examples that appeal to the consumer’s desire to be environmentally friendly.
Does your product and/or brand offer similar emotional value? If not, it might be worth looking into and should be applied to your messaging. It’ll certainly increase your value to your customers and, who knows, you might be able to charge more for it.
So there are the three questions to ask to help you set the perfect price for the value that you are creating for your customers. With these concepts in mind, moving your revenue by just 1 percent doesn’t seem to be all that difficult, right? Remember, even 1 percent can yield a big impact.
A version of this article originally appeared here.
Author: Michael Hsu, founder & CEO of DeepSky, is passionate about knowledge and entrepreneurship. He believes entrepreneurs should focus on taking over the world instead of building and managing their accounting departments. With that belief, he created DeepSky.