Every product or service needs to be priced. But pricing is very critical to determining profits. Obviously, the higher the price the higher the profit margin, but the economic principle of price elasticity comes into play (most of the time)- price is inversely related to demand quantity, especially for undifferentiated goods. To put it simply, the higher you price your items, the less people will buy and vice-versa. But this
relation is not proportional, which is how we can profit when priced right. The right price will give you the best demand for maximum profit. Sometimes selling less with a higher price might be the way to maximize profit. Conversely, selling more at a lower price might be better, but also consider your maximum output limitations. The other determining factor to determine maximum profit is the cost of supply which we assume remains the same in this article- the supply curve is another long discussion I’m not going to touch on. Which price tactic you choose depends on the gradient of the demand curve a business has. Many factors determine how steep or gentle your curve is, like competitors and most importantly brand differentiation. In time, we strive to achieve an inelastic demand curve, like Gucci or Lamborghini, where there is still demand quantity at such exorbitant prices.
Determining your pricing is more art than science, because realistically it would take a lot of time and resources to collate enough data to chart an actual demand curve. And small firms can’t afford it, so you have to rely on a few quick rules:
1) Competition’s pricing. Use your competitor as a benchmark for what is a realistic price.
2) Fixed/variable overhead costs. Includes cost of goods sold, always maintain a sizeable multiple of your product’s costs.
3) Time and effort needed. The harder or longer the service/product needs to be produced, a premium should be charged too, even if the raw ingredients are cheap.
4) How much value do you give. The more unique value you can give, the more you can charge.
One caveat to take note of is to transcend your generation’s price mentality. What do I mean? Many people price their products wrongly because they themselves would not have paid such a price, 10-20 years ago. However, spending power has increased, inflation has occurred, dual-income, only child (little emperors, as they are known in China) are abundant, and our assumption of spending power is outdated. This is purely a mental fallacy because you are not in touch with society’s change. Similarly, pricing a computer at $4000 is simply infeasible now as compared to 10 years ago.
P.S Note to the economic undergrads reading; this is a simplistic observation on a practical, retail level and the terms used are in no means intended for academic research papers/reports, as descriptions might not fulfil your textbook requirements.
