- [Instructor] Hello, and welcome to this week's topic,
which is pricing.
So we'll think about how do you price
your product or your service?
How do you know what's a good price?
What are the strategies involved here
to get an effective price?
So we'll start with the basic parameters
and I'm gonna talk about three of them,
cost-based, competition-based and customer-based,
and then wanna walk through
some basic strategies and vocabulary.
So here's your homework.
First, which of these price strategies
do you think you will employ?
So here's a number of them.
And how do you think it might change over time?
And finally, how does pricing impact sustainability?
How might using sustainable practices affect the price?
How will this affect the ability of people to afford it?
And what are the trade-offs that you face
and how do you think that you will address them?
If you have a nonprofit organization,
where do you think that you're going to get the money?
And again, how might sustainability practices impact this?
So why does it matter?
Why are we spending a whole week on this?
Why is it important to have the right price?
What happens if the price is too low?
And what happens if the price is too high?
I'll let you think about this a minute.
So a price too low,
it might mean that it doesn't even cover your costs.
So you're selling something at a loss,
or just, if it's below what people
can reasonably expect to pay,
then you lose that little bit of margin on every sale.
And also, price can be an indicator of quality.
And what happens if you price it too high?
Well, it might be so high that nobody will buy it.
So there are some basic parameters here.
The price ceiling is consumer willingness to pay.
So what is the most that anybody is willing to pay?
And then in economics, we call this the reservation price.
So if you could somebody's mind
and learn what is the absolute maximum price
that they would be willing to pay,
that's called the reservation price,
and the very bottom, the price floor are your costs,
that for the most part, if the price that you charge
doesn't cover all of your costs,
you're going to be losing money
and you will not be in business for long.
And then in the middle, there's a lot of sort of,
a lot of middle ground here,
but you can think about what do your competitors charge?
What is the going rate in the marketplace
for a product or service like yours?
I imagine a lot of you have had this already,
but I want to make sure that you know it.
So variable costs are those that change
depending on how much you produce.
So if you're a farmer, the more that you grow,
the more labor that you use
and the more that you'll have to spend on labor,
but the more that you grow,
you'll need to spend more on inputs like seeds.
If you're a coffee shop,
the longer that you're open or the more busy that you are,
the more you have to pay for a little labor,
the more coffee and other supplies.
And in many times, marketing is a variable cost.
And so if you are spending a percentage of income
on marketing, then that would clearly be a variable cost.
In contracts, fixed costs,
also known as overhead costs, are those that do not change.
So no matter how much you produce,
some things are kind of fixed,
like your rent or your mortgage, the cost of equipment,
in many cases, the cost of office supplies,
whether you grow and sell a lot
or don't grow or sell anything,
just being in business, you have these overhead costs.
And in some cases, marketing might be fixed too.
So if you buy an advertisement on some media
for a fixed amount over time,
then this would be a fixed cost.
So it kind of, can kind of depend.
So one example of cost-based pricing
is to add up all of your costs.
And we'll see a few examples.
So you add up all your fixed costs.
You add up all your variable costs to get your total costs,
and then you divide by the expected volume.
So this is what we call the break even price.
This is what you would charge,
which would just cover all of your costs and no more.
So at the end of the day, if you sell everything,
you don't make any money, you don't lose any money,
you exactly break even.
So you can think about what would be costs like this
for a business like a restaurant?
What would be for a service business, for your business?
So think about what would be the various fixed
and variable costs that you might incur for your business.
So two pricing strategies based on cost
are cost-plus and target based,
and I will run you through each one.
So cost-plus is where you have a standard markup,
and this is fairly common in the retail industry.
So you base it on how much you are buying something for.
So say that you're buying an item for $20,
and this is what we call COGS or cost of goods sold.
So you might have a fixed 50% markup.
So you take that $20,
multiply times 0.5 and add it on.
So you sell the good for $30.
This is a 50% markup.
And since your margin is $10 on a $30 good,
your margin is 33%.
And these are terms that you will hear a lot
if you use this model.
A more interesting one perhaps came about,
and I'm going to cite an example of work I did
with a number of organic farmers some years ago.
So imagine that there's a farmer and her name is Sue,
and she raises fresh produce on 10 acres.
She decides that $60,000 is her goal,
that that is a viable income for her family.
That is the minimum that she will want to earn
to make it worth her while.
So she has to earn 6,000 an acre,
60,000 net divided by 10 acres.
And she grows a lot of things,
including 1/4 acre of carrots.
So she adds up all her costs.
She pays 200 for seeds and fuel and stuff.
She weighs 300 for marketing,
for all the farmer's market stalls fees
and fixed costs of 500.
And so her costs of growing this crop is $1,000,
and she expects a yield of 4,500 pounds.
So if you take this 1,000 and divide by 4,500,
that is her break even price.
Now, since she wants to earn 6,000 net per acre
on 1/4 of an acre, she wants to add 1,500.
So she adds the 1,000 to,
the 1,000 cost to 1,500 target net
and this yields 56 cents per pound.
So this should be sort of the minimum that she should charge
to earn what she hopes to earn,
and note that this assumes
that she sells all that she grows.
So, as in almost everything else in life,
this approach has pros and cons.
The pros is it's fairly straight forward.
If it's done right, it will ensure a profit.
And it stems from break even analysis
and knowing your costs.
So it's really important to know your costs.
The con are it doesn't really look at
what your customers want to pay,
what your competitors are charging.
And again, there's no signal of quality.
So as I had said, price can be a powerful signal of quality.
And if it doesn't reflect that,
it could send the wrong signal.
That might be that you charge too little
and someone will think there's something wrong
with your good and won't buy it.
We're gonna spend some time in class,
but think about, and come with a number of reasons,
why is it important for a business to know its costs?
And be ready to discuss this in class.
This is the end of part one.
So please go to part two.
Thank you.