A good business model helps you maximise the amount of potential profit you can make by working smart to reduce costs
it helps you with your pricing to make sure that you hang onto as much of the upside as you can.
Let’s look at it like this.
If you’re delivering a good or a service there’s a price that the customer will pay for it. You have a set of variable costs that it takes to create it. The difference between the two is the Value Created. This value created zone is a tug of war between you and the customer. Your task is to set your price to achieve the maximum sustainable yield for yourself. What you leave on the table is the customer surplus.
Pricing strategy is about how you deal with this. If you are a bespoke tailor, traditionally you push it as high as you can. If your business isn’t scalable then what you want is the highest price you can get for your time – all other things being equal.
If you’re Tesco on the other hand you push the price down to follow your improvements in business processes so that you can increase your market share at the expense of the competition. This “Golden Shavings” policy can be really effective and is frequently the policy of choice in retailing and electronic products.
However, neither of those extreme positions may suit you. What you need is the maximum sustainable yield. One way of achieving this is to split the difference between the maximum reserve price (the point at which the last fool says “I’m not paying that!”) and the price it costs you to produce it. So if the most you could possibly charge for a day’s consultancy was £2000 and your costs in delivering it were £400 per day, then your best yields overall would be achieved at a price of £1200 per day.
As you get better at whatever you’re doing and your cost price goes down, so the sustainable price can go down with it if you want more market share. On the other hand it might go up if your brand strength allows the maximum reserve price to rise. Like Picasso or the divine Miss Midler.
The important thing is to be absolutely clear about what your offer is and where you want to take the business
- More sales or a higher price
- Scalable or not
- What appetite have you for growth and process.
But if you keep these principles in mind, you’ll certainly do better than operating on a finger in the air basis.