The right price: how to determine it and earn more in a competitive environment
The value is in time
The price of a product or service is a matter of primary importance, as it critically affects revenue and profit. And at the same time, most companies set prices... essentially at random: according to competitors, through a cost premium, or simply "based on feelings." Because of this, the business is systematically earns less.
Most entrepreneurs are motivated and control the marketing and finances of their business, but can they measure how much value they create for their customers and what is the best price for a service or product? This question is not as simple as it seems. Without understanding how much value your business creates for customers, you are working blindly.
In the last article, I showed two fundamental things.
First, value is not equal to price. Value is measured in units of time and is defined as the time T that a product or service can save or add, taking into account the probability P that this will happen:
V = T × P.
Secondly, there are two sides to value – objective and subjective. The objective reflects the ability of a product or service to save a specific amount of time with a specific probability. The subjective one reflects the perception of the amount of such time through feelings, is expressed in the client's desire to pay, and most often differs from the objective one. Over time, the market equalizes the objective and subjective cost: overestimation is paid in losses, and underestimation is paid in lost profits.
Understanding these two key concepts allows you to set the maximum sustainable price.
In this article, we'll look at how to find the maximum sustainable price level that buyers are willing to pay, and then how to set a price higher than that of competitors without compromising sales.
Why companies are wrong about the price
In practice, the answer turns out to be quite simple and at the same time inconvenient: companies are measuring the wrong thing.
Any company has a set of familiar metrics: revenue, marginality, conversion, average check, LTV, market share, etc. Customer satisfaction, repeat purchases, and recommendations are also taken into account. All these indicators are important, but they have one thing in common — they do not measure the value created.
A company can grow in revenue and at the same time systematically earn less. It can have a high NPS and sell for less than customers are willing to pay for the product. It can focus on competitors and even win deals, but lose out in profits. Why is this happening? Because the price in these coordinate systems is not calculated, but is selected based on benchmarks: "this level in the market", "competitors have about the same amount", "cost plus margin", "they will not buy higher".
The company looks at what is easy to measure and ignores what really determines the price — the time it creates for the customer. Until it is measured, the price remains a guess.
What is the maximum sustainable price?
Let's take a moment to digress into the concept of a sustainable price. Imagine a ball on top of a smooth slide.
It is high, but it is not in balance for long and slides down at the slightest deviation. Now imagine the same ball on a flat surface. It's lower than at the top of the slide, but it has nowhere to go. And the third option is a ball in a hole. It is even lower, and it has an even more stable position.
The price of a product or service is a matter of primary importance, as it critically affects revenue and profit. And at the same time, most companies set prices... essentially at random: according to competitors, through a cost premium, or simply "based on feelings." Because of this, the business is systematically earns less.
Most entrepreneurs are motivated and control the marketing and finances of their business, but can they measure how much value they create for their customers and what is the best price for a service or product? This question is not as simple as it seems. Without understanding how much value your business creates for customers, you are working blindly.
In the last article, I showed two fundamental things.
First, value is not equal to price. Value is measured in units of time and is defined as the time T that a product or service can save or add, taking into account the probability P that this will happen:
V = T × P.
Secondly, there are two sides to value – objective and subjective. The objective reflects the ability of a product or service to save a specific amount of time with a specific probability. The subjective one reflects the perception of the amount of such time through feelings, is expressed in the client's desire to pay, and most often differs from the objective one. Over time, the market equalizes the objective and subjective cost: overestimation is paid in losses, and underestimation is paid in lost profits.
Understanding these two key concepts allows you to set the maximum sustainable price.
In this article, we'll look at how to find the maximum sustainable price level that buyers are willing to pay, and then how to set a price higher than that of competitors without compromising sales.
Why companies are wrong about the price
In practice, the answer turns out to be quite simple and at the same time inconvenient: companies are measuring the wrong thing.
Any company has a set of familiar metrics: revenue, marginality, conversion, average check, LTV, market share, etc. Customer satisfaction, repeat purchases, and recommendations are also taken into account. All these indicators are important, but they have one thing in common — they do not measure the value created.
A company can grow in revenue and at the same time systematically earn less. It can have a high NPS and sell for less than customers are willing to pay for the product. It can focus on competitors and even win deals, but lose out in profits. Why is this happening? Because the price in these coordinate systems is not calculated, but is selected based on benchmarks: "this level in the market", "competitors have about the same amount", "cost plus margin", "they will not buy higher".
The company looks at what is easy to measure and ignores what really determines the price — the time it creates for the customer. Until it is measured, the price remains a guess.
What is the maximum sustainable price?
Let's take a moment to digress into the concept of a sustainable price. Imagine a ball on top of a smooth slide.
It is high, but it is not in balance for long and slides down at the slightest deviation. Now imagine the same ball on a flat surface. It's lower than at the top of the slide, but it has nowhere to go. And the third option is a ball in a hole. It is even lower, and it has an even more stable position.
If we return to economic realities, then in the first case you set the price higher than the value that is in the product, and therefore buyers quickly go to substitute goods — for example, they buy chicken instead of cod.
In the second case, you have set a price that is very close to the value you are creating. It makes no sense for the client to look for an alternative.
In the third case, the competition forced you to sell your product for less than the buyers are willing to pay for it. They're happy, and you're in constant danger of going broke and constantly looking for ways to cut costs.
Thus, the maximum sustainable price is the price that is very close to the value created for the customer. Not higher, because the market will correct you, and not lower, because you yourself will reduce your profits.
This is the point at which price ceases to be a compromise and becomes a manageable outcome. It makes sense to strive for it if the task is not just to sell, but to earn the most possible over a long distance.
Only by understanding what value you are creating for the client can you set the maximum and at the same time stable price for him.
How to calculate the value in practice
There are many metrics available on the market to determine the value created or added. They can be roughly divided into two categories.
Qualitative — how satisfied the customer is, whether they are ready for repeat purchases and recommendations, and what is the frequency and duration of using the product or service.
Quantitative — how much money, raw materials, time, energy, views, and so on are saved or won for the client.
Qualitative methods are useful as an additional tool, but they basically do not allow you to measure the amount of value created. Quantitative methods are closer to the goal, but most often they focus on easy-to-measure indicators that only partially reflect the real value hidden in your product or service.
Your goal is to set the maximum sustainable price, not just to find out what benefits you bring to the customer. And for this, it is necessary to move on to measuring value in its true units — in time.
Let's take two small businesses for example, client A and client B. They both mine, say, crushed stone. One spends an average of 6 hours mining a ton, while the other spends 8 hours. Your company has created a device that allows you to extract a ton of crushed stone in 2 hours.
If you're going to measure the economic impact in tons, you should charge the same price for the device to both customer A and customer B. Almost everyone does that.
But if you estimate the value created in its true units, that is, in hours, then you should set a higher price for customer B, since you save more time per ton for him than for customer A.
How much higher? For customer A, you reduce the production time by 6 − 2 = 4 hours, and for customer B — by 8 − 2 = 6 hours. This means that for customer B, the value of your device is 1.5 times higher.
But how to determine the price of your device in money? For example, to produce the same 1,000 tons per year, Customer A will need not 6,000 hours, but only 2,000 hours, saving 4,000 hours. And client B will need not 8000 hours, but the same 2000 hours — the savings will amount to 6000 hours.
At the same time, if the market salary costs are approximately the same and equal, for example, 1000 rubles per hour, then client A will save 4 million rubles, and client B — 6 million rubles.
It is also known that your device will run for 10,000 hours with a 90% probability, meaning it will run for an average of 9,000 hours. This means that the effect for both clients will last 4.5 years. As a result, the device will have a monetary effect: for client A — about 18 million rubles, for client B — about 27 million rubles.
As a result, for company A, you can set the price of the device close to 18 million rubles, but not equal, otherwise the entire effect for the client will be zero. For company B— it is already closer to 27 million rubles. That is, with a difference of 1.5 times, as we expected. To simplify matters, we assume that A and B have the ability to pay such money.
Having estimated the actual value created, expressed in hours, you get the opportunity to calculate the maximum price that the client is willing to pay and set the maximum individual price.
The main advantage of this method is that you do not need to bring the future value of money to the present day, as required by the classical discounted cash flow (DCF) method.
An hour today as value is equal to an hour in 100 years, so you simply add up the hours saved and use the current cost of money to convert time into money for a specific customer. It is a strong and practical alternative to DCF.
How to set a price above the competition and not lose sales
Now let's add a competitor. Since a competitor produces an analog, not an exact copy of your device, its characteristics are clearly different from yours. For example, your machine extracts a ton of crushed stone in 2 hours with a probability of 80%: possible breakdowns, additional readjustment, idle operation. For a competitor, this figure is 2 hours and 85%. For simplicity, let's assume that the total lifetime of the devices is the same.
In order for your machine to create a value for the customer equal to one hour, it, with 80% reliability, will lose 20% of the customer's working time, and only 15% for the competitor. That is, a competitor can set a price for his device even higher than you, but he gives a price... lower. He hasn't read this article and is trying to take the client away at the cost of unearned profits or even losses.
What can be done in this situation? Price competition is the worst possible behavior in the market. It is better to focus not on reducing the price, but on creating more value for the customer. Let's recall the value formula: V = T × P. To beat a competitor, you need to create more value.
One option is to improve P, meaning there is a chance that everything will work out as promised. For example, to bring the device to reliability of P = 95% through technical improvement or service. Then your machine will lose only 5% of the customer's time to create an hour of value. Most importantly, there will be fewer breakdowns and downtime. At this point, you have already moved ahead and can set a price about 12% higher than that of a competitor.
Moreover, the market very often values reliability more than economy, especially if customers are rigidly tied to the delivery schedule, do not want to pay fines for schedule disruptions and prefer predictability in their business.
The second way is to increase T, that is, the expected total lifetime of your device. This can be done through maintenance, provision of spare parts, maintenance, or other solutions that extend the useful life of the product for the customer. If the device lasts longer and creates value for longer, this is again a reason to charge a higher price.
There is another effective way. In the previous article, we distinguished the objective cost of Vo and the perceived subjective cost of Vs. Above, we used objective cost, but customers often make decisions through subjective perception. And this can also be controlled.
The customer can and should get the impression that your device is a significantly more valuable acquisition than a competitor's product. This can be achieved in many inexpensive ways that increase the perception of the cost components - T and P: better exterior design, better packaging, more interesting name — for example, "Bork" seems more luxurious than "Friend" — faster response to requests, attentive attitude to complaints and wishes. And it is necessary to communicate with the client more often, since everything familiar and familiar seems more reliable, and therefore valuable, like a familiar brand versus a new one, even if it is cheaper.
The ideal option is to create the impression that you have a completely different product than your competitor. This completely disqualifies the client from making a direct price comparison. You can't seriously compare the price of a vacuum cleaner and a coffee grinder. This is a very difficult task for crushed stone mining machines, but for a huge number of products and services it is a feasible and often used tactic.
That's why Disneyland sells happiness, not just amusement park services. Tour operators sell adventure, not just a trip. Yogurt producers are concerned about health, not a fermented milk product. There are thousands of examples.
What does this give the business?
By understanding the value created through its true nature, where V = T × P, you gain an informed market position and effective pricing tools in competitive markets.
The price is not only the result of negotiations and not only the consequence of the market. This is a function of the value created. If you can't determine the time you're creating for a customer, you don't know your value. If you don't know your value, you can't put the right price. And if you can't get the right price, you're inevitably underpaid.
Try to estimate how much time your business creates for its customers. If this is difficult for you to do, then you are far from understanding how much value you are creating for them. By all means solve this problem for yourself or... continue to set prices, following your intuition.
Original version of the article is here.
In the second case, you have set a price that is very close to the value you are creating. It makes no sense for the client to look for an alternative.
In the third case, the competition forced you to sell your product for less than the buyers are willing to pay for it. They're happy, and you're in constant danger of going broke and constantly looking for ways to cut costs.
Thus, the maximum sustainable price is the price that is very close to the value created for the customer. Not higher, because the market will correct you, and not lower, because you yourself will reduce your profits.
This is the point at which price ceases to be a compromise and becomes a manageable outcome. It makes sense to strive for it if the task is not just to sell, but to earn the most possible over a long distance.
Only by understanding what value you are creating for the client can you set the maximum and at the same time stable price for him.
How to calculate the value in practice
There are many metrics available on the market to determine the value created or added. They can be roughly divided into two categories.
Qualitative — how satisfied the customer is, whether they are ready for repeat purchases and recommendations, and what is the frequency and duration of using the product or service.
Quantitative — how much money, raw materials, time, energy, views, and so on are saved or won for the client.
Qualitative methods are useful as an additional tool, but they basically do not allow you to measure the amount of value created. Quantitative methods are closer to the goal, but most often they focus on easy-to-measure indicators that only partially reflect the real value hidden in your product or service.
Your goal is to set the maximum sustainable price, not just to find out what benefits you bring to the customer. And for this, it is necessary to move on to measuring value in its true units — in time.
Let's take two small businesses for example, client A and client B. They both mine, say, crushed stone. One spends an average of 6 hours mining a ton, while the other spends 8 hours. Your company has created a device that allows you to extract a ton of crushed stone in 2 hours.
If you're going to measure the economic impact in tons, you should charge the same price for the device to both customer A and customer B. Almost everyone does that.
But if you estimate the value created in its true units, that is, in hours, then you should set a higher price for customer B, since you save more time per ton for him than for customer A.
How much higher? For customer A, you reduce the production time by 6 − 2 = 4 hours, and for customer B — by 8 − 2 = 6 hours. This means that for customer B, the value of your device is 1.5 times higher.
But how to determine the price of your device in money? For example, to produce the same 1,000 tons per year, Customer A will need not 6,000 hours, but only 2,000 hours, saving 4,000 hours. And client B will need not 8000 hours, but the same 2000 hours — the savings will amount to 6000 hours.
At the same time, if the market salary costs are approximately the same and equal, for example, 1000 rubles per hour, then client A will save 4 million rubles, and client B — 6 million rubles.
It is also known that your device will run for 10,000 hours with a 90% probability, meaning it will run for an average of 9,000 hours. This means that the effect for both clients will last 4.5 years. As a result, the device will have a monetary effect: for client A — about 18 million rubles, for client B — about 27 million rubles.
As a result, for company A, you can set the price of the device close to 18 million rubles, but not equal, otherwise the entire effect for the client will be zero. For company B— it is already closer to 27 million rubles. That is, with a difference of 1.5 times, as we expected. To simplify matters, we assume that A and B have the ability to pay such money.
Having estimated the actual value created, expressed in hours, you get the opportunity to calculate the maximum price that the client is willing to pay and set the maximum individual price.
The main advantage of this method is that you do not need to bring the future value of money to the present day, as required by the classical discounted cash flow (DCF) method.
An hour today as value is equal to an hour in 100 years, so you simply add up the hours saved and use the current cost of money to convert time into money for a specific customer. It is a strong and practical alternative to DCF.
How to set a price above the competition and not lose sales
Now let's add a competitor. Since a competitor produces an analog, not an exact copy of your device, its characteristics are clearly different from yours. For example, your machine extracts a ton of crushed stone in 2 hours with a probability of 80%: possible breakdowns, additional readjustment, idle operation. For a competitor, this figure is 2 hours and 85%. For simplicity, let's assume that the total lifetime of the devices is the same.
In order for your machine to create a value for the customer equal to one hour, it, with 80% reliability, will lose 20% of the customer's working time, and only 15% for the competitor. That is, a competitor can set a price for his device even higher than you, but he gives a price... lower. He hasn't read this article and is trying to take the client away at the cost of unearned profits or even losses.
What can be done in this situation? Price competition is the worst possible behavior in the market. It is better to focus not on reducing the price, but on creating more value for the customer. Let's recall the value formula: V = T × P. To beat a competitor, you need to create more value.
One option is to improve P, meaning there is a chance that everything will work out as promised. For example, to bring the device to reliability of P = 95% through technical improvement or service. Then your machine will lose only 5% of the customer's time to create an hour of value. Most importantly, there will be fewer breakdowns and downtime. At this point, you have already moved ahead and can set a price about 12% higher than that of a competitor.
Moreover, the market very often values reliability more than economy, especially if customers are rigidly tied to the delivery schedule, do not want to pay fines for schedule disruptions and prefer predictability in their business.
The second way is to increase T, that is, the expected total lifetime of your device. This can be done through maintenance, provision of spare parts, maintenance, or other solutions that extend the useful life of the product for the customer. If the device lasts longer and creates value for longer, this is again a reason to charge a higher price.
There is another effective way. In the previous article, we distinguished the objective cost of Vo and the perceived subjective cost of Vs. Above, we used objective cost, but customers often make decisions through subjective perception. And this can also be controlled.
The customer can and should get the impression that your device is a significantly more valuable acquisition than a competitor's product. This can be achieved in many inexpensive ways that increase the perception of the cost components - T and P: better exterior design, better packaging, more interesting name — for example, "Bork" seems more luxurious than "Friend" — faster response to requests, attentive attitude to complaints and wishes. And it is necessary to communicate with the client more often, since everything familiar and familiar seems more reliable, and therefore valuable, like a familiar brand versus a new one, even if it is cheaper.
The ideal option is to create the impression that you have a completely different product than your competitor. This completely disqualifies the client from making a direct price comparison. You can't seriously compare the price of a vacuum cleaner and a coffee grinder. This is a very difficult task for crushed stone mining machines, but for a huge number of products and services it is a feasible and often used tactic.
That's why Disneyland sells happiness, not just amusement park services. Tour operators sell adventure, not just a trip. Yogurt producers are concerned about health, not a fermented milk product. There are thousands of examples.
What does this give the business?
By understanding the value created through its true nature, where V = T × P, you gain an informed market position and effective pricing tools in competitive markets.
The price is not only the result of negotiations and not only the consequence of the market. This is a function of the value created. If you can't determine the time you're creating for a customer, you don't know your value. If you don't know your value, you can't put the right price. And if you can't get the right price, you're inevitably underpaid.
Try to estimate how much time your business creates for its customers. If this is difficult for you to do, then you are far from understanding how much value you are creating for them. By all means solve this problem for yourself or... continue to set prices, following your intuition.
Original version of the article is here.