Dien Rice
November 12, 2006, 12:53 AM
Here's a story of what one guy (William Cohen) did ... Which reveals a lot about the "psychology" of pricing!
First, here's the way a lot of business people (especially new ones) look at pricing. They look at their cost to create the product or to provide the service. Then, they add on a bit of profit for themselves. And that's the price for their product!
So, for example, let's say you have a business scanning a client's computer for viruses, and removing the viruses when they are found. Let's say (to make it simple) that it takes an hour to scan a computer and remove the viruses. Also, to make it simple, the business person can use free anti-virus software, so there's no additional software cost. (Eg. like using this software (http://free.grisoft.com).)
Well, if this person, say, values his time at $20 an hour, then he might charge from $20 to $30 for the whole service. But is that the approach he should take?
Okay, now here's what William Cohen did to show that there's no one "TRUE" price for anything! He was the director of the Small Business Institute at California State University. (This example is told in the book "Making It!" by E. Joseph Cossman and William A. Cohen (p. 152).)
He created the following classroom exercise.
He divided the students in his class into two equal groups - "buyers" and "sellers". Then, he separated them so he could tell each group confidental information.
The "sellers" were told that they are selling a computer system. However, their system was now obsolete! If they couldn't sell it within a day, they had to give it away for scrap and receive nothing!
Then, he separately told the "buyers" that their entire business was built around this particular computer system (that the "sellers" were selling). They NEEDED it to do business! However, their system had broken down. If they couldn't buy an immediate replacement within one day, they had to buy a similar system from elsewhere for $50,000 !
Then, he let the "buyers" and "sellers" back together in the same room. They were each given 20 minutes to get a "deal" to either sell or buy the computer system.
The "sellers" knew if they had no sale, they would get nothing! And the "buyers" knew if there was no sale, they would have to pay $50,000 to get a system from someone else. And remember, "buyers" didn't know the situation of the "seller", and similarly, "sellers" didn't know the situation of the "buyer".
So - what happened in the end?
You might think that the computer system would "sell" for around $25,000 - halfway between the seller's minimum and the buyer's maximum. But if you thought that - you'd be wrong!
In fact, in the many deals in class for the exact same product, between buyers and sellers with the exact same conditions - the computer system "sold" for anywhere from a few dollars, all the way up to almost the full $50,000 !
And in all cases, both the buyer and seller thought the price was "fair", whatever price they eventually agreed to - that is, until they learned about the other person's "problem"!
The point is - there are many "right" prices for a product, and it all depends on your point of view.
In this example, the "buyer" gets a good "deal" if he buys it for less than $50,000. And the "seller" gets a good "deal" if she sells it for more than $0 !
Back to the example earlier on - that's why looking at your cost, then adding on a bit of profit, is often NOT the best way to price your product or service.
Instead, you should also look at it from your customer's point of view... How much would your product or service be "worth" to them? That could be related to what "problem" it solves... And how much this is could vary from customer to customer.
Going back to the example of selling a computer-virus-removal service, how much would that be worth to the customer?
To a customer who has an old computer that they never use, which they're planning to replace soon anyway - the virus removal service might not be worth much. So they probably wouldn't be willing to pay much for it.
However, to a customer which has valuable business data and software on their computer, and who needs the computer to be up and running (and reliable) within the next few hours for their business to keep running - they could be willing to pay hundreds of dollars for the virus-removal service (if it could be done reliably and quickly).
In both cases, we're talking about the exact same service.
I just thought I'd share these interesting examples!
Hope you liked the post. Your ideas and examples I'm also interested in...
- Dien Rice
First, here's the way a lot of business people (especially new ones) look at pricing. They look at their cost to create the product or to provide the service. Then, they add on a bit of profit for themselves. And that's the price for their product!
So, for example, let's say you have a business scanning a client's computer for viruses, and removing the viruses when they are found. Let's say (to make it simple) that it takes an hour to scan a computer and remove the viruses. Also, to make it simple, the business person can use free anti-virus software, so there's no additional software cost. (Eg. like using this software (http://free.grisoft.com).)
Well, if this person, say, values his time at $20 an hour, then he might charge from $20 to $30 for the whole service. But is that the approach he should take?
Okay, now here's what William Cohen did to show that there's no one "TRUE" price for anything! He was the director of the Small Business Institute at California State University. (This example is told in the book "Making It!" by E. Joseph Cossman and William A. Cohen (p. 152).)
He created the following classroom exercise.
He divided the students in his class into two equal groups - "buyers" and "sellers". Then, he separated them so he could tell each group confidental information.
The "sellers" were told that they are selling a computer system. However, their system was now obsolete! If they couldn't sell it within a day, they had to give it away for scrap and receive nothing!
Then, he separately told the "buyers" that their entire business was built around this particular computer system (that the "sellers" were selling). They NEEDED it to do business! However, their system had broken down. If they couldn't buy an immediate replacement within one day, they had to buy a similar system from elsewhere for $50,000 !
Then, he let the "buyers" and "sellers" back together in the same room. They were each given 20 minutes to get a "deal" to either sell or buy the computer system.
The "sellers" knew if they had no sale, they would get nothing! And the "buyers" knew if there was no sale, they would have to pay $50,000 to get a system from someone else. And remember, "buyers" didn't know the situation of the "seller", and similarly, "sellers" didn't know the situation of the "buyer".
So - what happened in the end?
You might think that the computer system would "sell" for around $25,000 - halfway between the seller's minimum and the buyer's maximum. But if you thought that - you'd be wrong!
In fact, in the many deals in class for the exact same product, between buyers and sellers with the exact same conditions - the computer system "sold" for anywhere from a few dollars, all the way up to almost the full $50,000 !
And in all cases, both the buyer and seller thought the price was "fair", whatever price they eventually agreed to - that is, until they learned about the other person's "problem"!
The point is - there are many "right" prices for a product, and it all depends on your point of view.
In this example, the "buyer" gets a good "deal" if he buys it for less than $50,000. And the "seller" gets a good "deal" if she sells it for more than $0 !
Back to the example earlier on - that's why looking at your cost, then adding on a bit of profit, is often NOT the best way to price your product or service.
Instead, you should also look at it from your customer's point of view... How much would your product or service be "worth" to them? That could be related to what "problem" it solves... And how much this is could vary from customer to customer.
Going back to the example of selling a computer-virus-removal service, how much would that be worth to the customer?
To a customer who has an old computer that they never use, which they're planning to replace soon anyway - the virus removal service might not be worth much. So they probably wouldn't be willing to pay much for it.
However, to a customer which has valuable business data and software on their computer, and who needs the computer to be up and running (and reliable) within the next few hours for their business to keep running - they could be willing to pay hundreds of dollars for the virus-removal service (if it could be done reliably and quickly).
In both cases, we're talking about the exact same service.
I just thought I'd share these interesting examples!
Hope you liked the post. Your ideas and examples I'm also interested in...
- Dien Rice
