Are your prices too low?

I just returned from a business trip to Israel, where I also had a little time to tour with an amazing guide. He took my companions and me from Jerusalem to the northern part of the Sea of Galilee, relating the biblical and recent history of each place we passed. He took us to places tourists couldn’t ordinarily go. He was charming, funny and extremely well-informed. For logistical reasons, I didn’t find out the price of the tour until the end of the day. I was expecting to pay perhaps $200-500. And I was glad to pay it. I got an incredible education.

His price? $300 a day. Not per person. Per day. My share worked out to $60.

You see, my guide priced his tour based on his costs. He loves to visit Israel, so he charges enough on tours to cover the cost of his airfare. But his pricing should be based on the value to his customers. I felt so bad paying only $60 that I gave him a substantial tip. But if you are a small business selling products or services, it’s very rare that your customers will think to tip you. They assume the price you’ve set out is fair.

So back to my original question- are your prices too low? If you price based on your time and materials instead of the value your customer receives, the answer is “Yes.” If your prices are too low, of course you will be missing out on profit, but there are other, more dangerous consequences as well.

The danger of pricing too low

Customers perceive pricing as shorthand for value. When customers can’t evaluate the quality of a product or service, they let the price be their guide. Diamonds are a good example. Most consumers can’t actually tell the difference between diamonds rated S1 or S2, so they buy based on what they are willing to spend.

If you sell something even moderately complex, it is easy to price yourself under and out of the market. Imagine I knew beforehand that my tour of Israel would only cost $60. I might have opted to do something else, thinking, “How good could it be?”

Determining the price

• It requires more effort to develop value pricing than cost-plus pricing, but here are some tips for your small business.
• Competitive analysis. Know what your competitors are charging and price yourself based on your value relative to their offerings.
• Customer research. Interview past customers to learn what they value about your offerings. If their value seems greater than what you charge, raise prices.
• Don’t be afraid to go for it. Price increases invariably spark lively and lengthy debate in companies. But most of the time customers hardly notice the increase (unless, as in the case of Wendy’s Junior Bacon Cheeseburger, you try to price well beyond perceived value. Each time Wendy’s charges more than $1, the experiment fails).
• Calculate your customer’s value. Some companies, especially business-to-business companies, can calculate how much value their products or services will give a customer. Take the time to do it, and share the results with your customers.

Finally, if you are ever in need of a private tour guide in Israel, send me a note. But hopefully his prices will be higher when you write- and the experience will be worth it.