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- [Instructor] Hello, and
welcome to this week's topic,

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which is pricing.

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So we'll think about how do you price

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your product or your service?

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How do you know what's a good price?

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What are the strategies involved here

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to get an effective price?

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So we'll start with the basic parameters

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and I'm gonna talk about three of them,

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cost-based, competition-based
and customer-based,

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and then wanna walk through

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some basic strategies and vocabulary.

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So here's your homework.

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First, which of these price strategies

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do you think you will employ?

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So here's a number of them.

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And how do you think it
might change over time?

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And finally, how does pricing
impact sustainability?

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How might using sustainable
practices affect the price?

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How will this affect the
ability of people to afford it?

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And what are the trade-offs that you face

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and how do you think that
you will address them?

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If you have a nonprofit organization,

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where do you think that
you're going to get the money?

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And again, how might sustainability
practices impact this?

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So why does it matter?

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Why are we spending a whole week on this?

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Why is it important to
have the right price?

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What happens if the price is too low?

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And what happens if the price is too high?

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I'll let you think about this a minute.

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So a price too low,

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it might mean that it doesn't
even cover your costs.

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So you're selling something at a loss,

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or just, if it's below what people

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can reasonably expect to pay,

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then you lose that little
bit of margin on every sale.

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And also, price can be
an indicator of quality.

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And what happens if you price it too high?

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Well, it might be so high
that nobody will buy it.

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So there are some basic parameters here.

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The price ceiling is
consumer willingness to pay.

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So what is the most that
anybody is willing to pay?

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And then in economics, we call
this the reservation price.

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So if you could somebody's mind

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and learn what is the
absolute maximum price

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that they would be willing to pay,

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that's called the reservation price,

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and the very bottom, the
price floor are your costs,

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that for the most part, if
the price that you charge

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doesn't cover all of your costs,

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you're going to be losing money

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and you will not be in business for long.

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And then in the middle,
there's a lot of sort of,

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a lot of middle ground here,

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but you can think about what
do your competitors charge?

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What is the going rate in the marketplace

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for a product or service like yours?

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I imagine a lot of you
have had this already,

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but I want to make sure that you know it.

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So variable costs are those that change

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depending on how much you produce.

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So if you're a farmer,
the more that you grow,

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the more labor that you use

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and the more that you'll
have to spend on labor,

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but the more that you grow,

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you'll need to spend more
on inputs like seeds.

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If you're a coffee shop,

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the longer that you're open
or the more busy that you are,

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the more you have to
pay for a little labor,

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the more coffee and other supplies.

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And in many times, marketing
is a variable cost.

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And so if you are spending
a percentage of income

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on marketing, then that would
clearly be a variable cost.

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In contracts, fixed costs,

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also known as overhead costs,
are those that do not change.

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So no matter how much you produce,

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some things are kind of fixed,

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like your rent or your
mortgage, the cost of equipment,

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in many cases, the cost
of office supplies,

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whether you grow and sell a lot

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or don't grow or sell anything,

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just being in business, you
have these overhead costs.

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And in some cases, marketing
might be fixed too.

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So if you buy an
advertisement on some media

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for a fixed amount over time,

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then this would be a fixed cost.

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So it kind of, can kind of depend.

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So one example of cost-based pricing

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is to add up all of your costs.

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And we'll see a few examples.

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So you add up all your fixed costs.

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You add up all your variable
costs to get your total costs,

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and then you divide by
the expected volume.

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So this is what we call
the break even price.

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This is what you would charge,

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which would just cover all
of your costs and no more.

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So at the end of the day,
if you sell everything,

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you don't make any money,
you don't lose any money,

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you exactly break even.

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So you can think about what
would be costs like this

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for a business like a restaurant?

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What would be for a service
business, for your business?

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So think about what would
be the various fixed

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and variable costs that you
might incur for your business.

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So two pricing strategies based on cost

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are cost-plus and target based,

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and I will run you through each one.

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So cost-plus is where you
have a standard markup,

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and this is fairly common
in the retail industry.

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So you base it on how much
you are buying something for.

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So say that you're buying an item for $20,

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and this is what we call
COGS or cost of goods sold.

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So you might have a fixed 50% markup.

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So you take that $20,

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multiply times 0.5 and add it on.

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So you sell the good for $30.

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This is a 50% markup.

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And since your margin
is $10 on a $30 good,

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your margin is 33%.

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And these are terms
that you will hear a lot

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if you use this model.

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A more interesting one perhaps came about,

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and I'm going to cite
an example of work I did

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with a number of organic
farmers some years ago.

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So imagine that there's a
farmer and her name is Sue,

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and she raises fresh produce on 10 acres.

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She decides that $60,000 is her goal,

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that that is a viable
income for her family.

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That is the minimum that
she will want to earn

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to make it worth her while.

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So she has to earn 6,000 an acre,

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60,000 net divided by 10 acres.

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And she grows a lot of things,

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including 1/4 acre of carrots.

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So she adds up all her costs.

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She pays 200 for seeds and fuel and stuff.

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She weighs 300 for marketing,

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for all the farmer's market stalls fees

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and fixed costs of 500.

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And so her costs of growing
this crop is $1,000,

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and she expects a yield of 4,500 pounds.

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So if you take this 1,000
and divide by 4,500,

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that is her break even price.

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Now, since she wants to
earn 6,000 net per acre

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on 1/4 of an acre, she wants to add 1,500.

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So she adds the 1,000 to,

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the 1,000 cost to 1,500 target net

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and this yields 56 cents per pound.

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So this should be sort of the
minimum that she should charge

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to earn what she hopes to earn,

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and note that this assumes

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that she sells all that she grows.

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So, as in almost everything else in life,

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this approach has pros and cons.

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The pros is it's fairly straight forward.

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If it's done right, it
will ensure a profit.

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And it stems from break even analysis

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and knowing your costs.

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So it's really important
to know your costs.

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The con are it doesn't really look at

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what your customers want to pay,

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what your competitors are charging.

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And again, there's no signal of quality.

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So as I had said, price can be
a powerful signal of quality.

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And if it doesn't reflect that,

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it could send the wrong signal.

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That might be that you charge too little

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and someone will think
there's something wrong

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with your good and won't buy it.

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We're gonna spend some time in class,

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but think about, and come
with a number of reasons,

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why is it important for a
business to know its costs?

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And be ready to discuss this in class.

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This is the end of part one.

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So please go to part two.

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Thank you.