Just finished a project, which gives me a few days to reflect, work on my personal business-plan, aka career philosophy, and write blog posts about pricing and stuff. A few months ago, I purchased the second edition of the book “The Strategy and Tactics of Pricing.” It’s a really good read, though also a complex one—I’m on page 80 of 450, and I started reading in December! That said, having been exposed to setting my own prices for the services I provide, also taught me a thing or two already.

Understanding pricing really means two things: understanding the numbers and understanding the psychology behind why people are willing to charge or pay x amount for something. The difficulty is mainly that information is incomplete. I can’t judge 100% what contextual factor made a customer decide to go the other way, or why the competition charges 3 x less than my product. At the same time, this fuzziness also means that pricing is not just a matter for the “finance guys,” it’s a matter of doing your homework, experimenting, and some instinct.

Pricing itself is a subject that is actually relevant to everyone [I'm excluding millionaires here, though they may consider the price of their yachts and Rolls Royce's sometime]. It’s something that matters when pricing yourself (what is a fair wage or fee for people to pay you?); when pricing products and services; and when considering paying for products and services (why does a certain price seem to high or like a good buy?).

Pricing yourself

According to my nice bible on consulting, there are three main ways that I can set my own prices. I can work on an hourly / weekly / monthly / etc. fee, I can charge a single fee for the whole project, and I can be paid for reserved time [aka, I set aside x amount of days per month for client y]. Consultants typically charge a lot and that is not for arrogance reasons. Rather, one factor is the amount of risk that you incur. By committing to one client, who may only need you for an undetermined amount of time, you risk forgoing other income. Hence you charge more per project. Something like reserved time over a longer period of time would be less risky, hence you can charge less for that.

Of course, it’s also a matter of what value you bring to the table, which is really a two-edged sword: is the value that you bring, the skill-sets that you have acquired (and which cost you money to acquire)? Or is it the value that your client attributes to it? It is always the latter, though if that value is lower than what it costs to produce it, you’re making a loss and should rethink your business.

Similarly, it should optimally be so that when you apply for a job, you have an estimate of the financial value that you bring to the company. This isn’t always made clear, often you have a salary-indication showing what you are worth to them, but your value-contribution may very likely be higher (or lower) than what is expected. Negotiating in such a situation requires sufficient knowledge about that value—yours and theirs.

Pricing products and services

The mechanics of pricing here is much the same, though perhaps simpler to understand. At least, from a cost-perspective, which should be just a matter of adding up the ingredients and the (wo)man-hours. But cost in itself does not tell you enough. For one, there are economies of scope and scale. Second, there are avoidable costs. And third, we live in a era where the cost of (re)production can often be minimal [I should note at this point, that the edition of the book that I bought is from 199X; a 4th edition came out in 2005, which, I imagine, approaches the digital economy more].

And of course there is also the matter of the competition (cost-based pricing only works well in monopolistic situations—”it costs what it costs, what are you going to do about it, punk?”) and, again, the value that the customer places on your product. But this kind of interplay can be really complex and is exactly why I decided to read this book.

A note on the avoidable costs part. Recently, I was looking for a laptop-bag and came across what I thought was a great deal. Everywhere I looked the bag cost €40. But one place had it for €25. Without thinking I added it into my basket [this is e-commerce] and wanted to order it. Until I saw that sending it would cost €20 [other's charged €5], bringing it to the same sum. This was actually a coincidence, as they charged €20 for sending other products as well. Why does one company charge much more than others for sending materials, but less for the materials itself? My acquired wisdom taught me that this is because it encourages people to buy lots of products at once. Because people buy a lot, the store has to store less inventory over time, which represents a saving that it can translate into the cost of its products.

The inventory cost is an avoidable cost that you, as a store, can tweak up, down, or away. Just like you can outsource certain parts of your operation, etc. etc., you can make decisions on an organisational level which will have an effect on your costs. And because your costs don’t matter to your customer, the value that he attributes to your product does, you have to change your costs and margins to match that picture. Did that make sense? I had to re-read that part of the book a few times to get it myself, sort of.

The price that you and I are willing to pay

While marketeers would like you to think that this is all a psychology game, it is in fact still a psychology + numbers game at this stage. When my income is low, making a purchase that consumes a large percentage of it, will make me very price-sensitive and vice versa. If I use an app that saves me x amount of time [allowing me to earn more money], then that app has a certain value to me relative to that.

But there are psychological aspects as well. My Mac, for example: I know it saves me time to do what I do (=financial value). But I also feel good about being on a Mac (=psychological value). Or the digital SLR I am planning to buy. I briefly browsed the second-hand market, but abandoned the idea because I value the security of buying a new product. My expertise in cameras is too low to place my faith in a second-hand camera, even if it is half price. Had the new Mac not come out recently, I would’ve probably bought a second-hand one, because I know about 10 different tests to make sure that it’s ok. The product’s reputation is a factor, but so is the customer’s expertise.

Setting a price is a matter of what value it has for a customer—real and imagined—and good marketeers can position their products wisely to convince customers of that.

Final thoughts

Don’t worry! Tech it Easy won’t become a pricing-orientated blog anytime soon. As interesting as it can be, it doesn’t quite hit that mainstream nerve, I don’t think. For me, it is just another puzzle to solve on the big canvas that is life. And perhaps, I made you curious about it also? If so, give me a buzz in the comments or send me a mail. As I’m here to learn, I’d love to discuss any questions you may have about this!

Vincent

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The coming weeks, I’ll be pretty busy with a business development project in the technology sector. As usual, I cannot discuss it in depth (ok, it’s Fight Club, we bash each other half to death every week and can’t talk about it), but I want to discuss some stumbling blocks that we’re sure to be hitting. To give you an idea, some of the questions are now:

• Patents and their limitations: while we have filed for a number already, the issues are whether there is prior art and how to deal with it, as well as whether patents are really enough protection against competitors. Since, I’ve attended a pretty interesting New Venture seminar last week on IP, I think that will be my next post.
• The usefulness of market research: I breached this topic before already, but I don’t believe in researching innovations that consumers cannot touch yet, and will instead focus on expert-input, I think, as well as getting a testable prototype ready as soon as possible (we’ll be looking for subjects!). I hope to have something more to write about it soon.
• Pricing strategy: this is really exciting! I’m reading the excellent book “The strategy and tactics of pricing” and am in the position to apply some of it’s lessons now. Thoughts about it to follow on Tech IT Easy soon, but to give you an idea, it’s about the battle between costs, what the competition charges, and what your customers want to pay for your product.
• Dealing with bureaucracy: Since, we’re going to be applying to an incubator, it might be interesting to see how that process goes.

In other, equally important news:

• Verteego: You may have noticed a new badge on our site. It’s the Verteego sustainability badge, which links to a report analysing our weblog. I’ll be trying to increase our grade a little there/here and will write about my impressions. I didn’t even know that I can take leave for pregnancy-reasons, wow!
• Public transport in the Netherlands: I don’t know how it is in your country, but we’re doing exciting RFID-related stuff here. Starting February, we’ll be going through the transition of going from a stamp to a beep, and I’ll write a little about my impressions here.

That’s all I can predict for now, and I hope to make it all a reality soon! Until the next time, on Tech IT Easy!

Vincent

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I’m sitting in the train, reflecting on the concept of “Free!”, having just listened to a podcast from the London School of Economics on the diminishing role of European citizenship—a British university, a very dry topic, my thoughts naturally drifted elsewhere. I’ve also been thinking about the dwindling state of print-media and the onslaught of digital media—a topic that has been beaten to death over the years.

I was wondering what made a university give its, let’s call them “words” away for a free, until I realised that the one thing that a university probably has in abundance is words. The same applies to print media, with an excess of its type of media, or radio stations, with an excess of music… etc., etc.

My theory of “freeness” is thus that you should release those things for free that you have in abundance. I’m sure there is a more formal economic theory about it, and I think it comes down to the idea of marginal value and that those things that have less marginal value can be released for free or cheap, while those with a higher marginal value should not be (please correct my interpretation in the comments, if I’m wrong).

The reason we are (or I am) so confused about this subject, is because things cost money. It costs money to produce a newspaper, which is why we are forced to look at adverts on every second page and pay a cover charge as well. So, it’s no wonder that we expect that by releasing stuff for free that they must be losing money!

I’m not a good economist, so I can’t throw a complicated formula at you, just that I think that you have to focus on other values, next to the commodity-cost of words / text / music, when selling a service. For universities, it’s the facilities and access to very smart people; for print newspapers, it’s the convenience of the paper at a fair price; for radio-stations, it’s the freshness of supply and witty comments. As long as you can differentiate yourself in areas like these, other things can essentially be given away for free.

As mentioned, I’m sure a theory exists about this, but I thought it would be a nice thought for today’s post.

A quiz to finish. What parts of following businesses could probably be released for free?

• A strategic consultancy
• A mail delivery company
• A gas station
• A word-processing software business
• A social network business
• An author of books

With at least one of these, I think it’s ok to say nothing at all. And I think that for none of them, it’s ok to say that everything should be free.

Vincent

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