I've previously posted plenty of columns on pricing techniques, but I've not yet shared the "organizing principle" that lies behind pricing. This key principle is this: "Optimum Price Reflects Perceived ROI."
"Optimum Price" is the price that creates the most profit, which requires balancing sales volume with per-unit profit. Achieving an optimum price point is difficult because it requires balancing two opposing tendencies:
- Lowering the price increases sales volume but decreases per-unit profit.
- Raising the price increases the per-unit profit but decreases sales volume.
The difficulty in achieving optimal pricing lies in the attempt to pick the highest price that buyers will tolerate while not decreasing sales volume by chasing customers away.
That's why "Perceived ROI" is so important. Now, as everyone knows (or should know), there are three general types of "salable" things:
- Commodities. The optimal price of commodities is determined by the ROI that the buyer believes will result from purchase and resale.
- B2C products/services. Businesses sell to consumers by convincing them that whatever is being sold will either decrease pain or increase pleasure or both. The optimal price gets as many buyers as possible at the highest price possible because they believe they'll be happier after purchasing the product.
- B2B products/services. Businesses sell to business with the understanding that whatever is sold will either decrease costs or increase revenue or both. The optimal price gets as many buyers as possible at the highest price possible because they believe they'll be more profitable after purchasing the product.
The essential point here is that it's the PERCEPTION of ROI that determines how much somebody will pay and whether they're likely to buy. The way to achieve an optimal price is therefore by increasing the perceived ROI, which naturally results in the ability to charge the highest price without negatively impacting sales volume
What this means is simple and essential: rather than getting trapped into trying to balance per-unit profit with sales volume, focus on increasing the perceived ROI, in which case you can raise your per-unit prices but not experience fewer unit sales.
And that, my friends, is why we do branding, product positioning and advertising--all of which are ways to increase perceived ROI. Q.E.D.