A commonly used strategy is to charge a (say) 50% margin relative to an estimate of variable costs. The idea is that assuming that the expected volume of transactions is achieved, the margin covers the fixed costs.
The biggest advantage of this method is that the margin is positive. Some of the pricing strategies discussed earlier in this blog don’t have this advantage.
The biggest disadvantage is that profit is not objectively being maximized.
Better pricing decisions can be made by a system that can learn from consumer choice.
Volume increases as price is reduced. So, can a big part of the market be captured by reducing margin to nearly zero?
Admittedly growth can be high with this strategy. The rationale can’t be to distribute fixed costs over more quantity because by the definition of this strategy, profit is not being maximized. A few things to be considered include:
- Competitors could also adopt this strategy. This will lead to a price war with the average customer getting away with a bargain. Its probably better to outperform competition on costs or the value proposition and set prices to the optimal price.
- If the plan is to dominate the market with more efficiency (lower costs) or by more features. The “insanely low” pricing could be used to get market attention quickly. Its probably better to give customers a free introductory offer and then allow prices to float to the optimal price.
- If the plan is to eventually raise margins, this is essentially a siege on the competition. It is best executed by someone that can outlast the competition. Obviously there is no argument for the optimal price here.
Allowing consumer choice to decide early will help guide product development before large investments are made.
Access to capital is an opportunity to discover consumer preferences instead of a “capture the market move”.
The theory of being a better business than the rest of the market can be tested with optimal pricing.
Consumers are usually a more efficient source of funding than investors.
When start-ups price low to capture the market, they lose an opportunity to verify their value propositions. Price is just one part of the value equation. Cost efficiency and the Value Proposition are the others. It is better to hear that the product needs to be improved rather than wait till a lot of investment has gone into capturing the market to and prices have to be raised.
Successful investors like Warren Buffet stayed away from the insurance industry for 2 out of 3 years to come roaring back when prices were higher.
Why not find something similar and price close to it with a small premium for features or a discount for the lack of a brand name?
Each customer experience is unique. Even though Starbucks was brewing coffee which was a relatively simple and arguably undifferentiated product in 1971, they could charge a different price. In 1971, this was because they could create a novel experience. Today Starbucks earns a premium for familiarity.
The uniqueness of customer experience and product justifies a price differential.
Even the most competitive environment like online retail justifies different prices for different retailers.
Pricing competitively is probably a good strategy in the absence of customer demand information such as when a store starts business.
Flying blind is comparable to ignoring customer data from actual purchases in the longer run.
Only an optimal pricing strategy can avoid the loss relative an informed pricing strategy.