Posted by: DrAlanRae | November 7, 2008

Getting the right price

One of my current projects is teaching a couple of modules on a Digital Marketing MSc for London School of Business and Finance.

This week we were talking about Business planning and metrics and I came across a couple of methods for working out what price to charge for your products or services. This is traditionally one of the hardest things to get right.

So – method one.

This depends on knowing the Maximum Reservation Price. What this means in English is the price at which the Last Fool says – for pity’s sake I’m not paying that. i.e it’s the highest price that anyone would ever pay.

So add your total variable costs of producing the item to the MRP and divide by 2.

As if by magic you have your optimal selling price at which to sell your product. As you get better at what you’re doing by going down the learning curve, your variable costs go down and so does your optimal selling price.

This is based on a linear view that for a fixed change in price you get a fixed change in volume. This is called price elasticity by economics wonks.

If like ‘er indoors you think this is a bit simplistic you might prefer method number 2 which depends on measuring the price elasticity.

It’s simple. The optimal price is  – (1/elasticity)

It’s negative because as the price goes up the volume goes down. (I know you can sometimes get more business by increasing your day rate but I suppose that the more product-like the offering the more this optimal pricing stuff is likely to work)

So how do you get at that I hear you cry.

Well I guess our friend Mr Google can help us with that. You could run 3 ads in parallel all offering the same product for slightly different prices and see how much the price affected the sales. That gives you the elasticity – and you’re away for slates.

Can’t wait to try it.

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Responses

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