“We lose money on every deal, but we make it up in volume.”

That cold joke was tossed around a dying company I worked for a couple of decades ago. Yet behind the gallows humor was a bare truth; the company was bleeding and part of the problem was in pricing our deals. Knowing what to charge is non-trivial, but survival-level important. This is especially true for start-ups: Price too high and you earn no revenues. Price too low and you slowly spiral into the muck of bankruptcy.

Knowing what to charge for products and services is often treated like a voodoo ritual, where mystic insight from corporate elders drive the decision. I once took over a marketing department for a software company and asked the innocent question “How did you decide on the product’s price?” The grizzled CEO said “That’s what all products in this market cost.” Unsatisfied with his analysis, I used a planned satisfaction survey to test pricing and discovered we could raise prices 15% without losing a single customer. We added 15% to our top line the next fiscal year by doing nothing.

Finding your initial price range is not difficult, but note my qualification. This exercise establishes a rough range of where your product pricing can be. With boundaries set, you can then test price points in a rational way. To get started, you basically need to establish three critical prices:

Value price

In perfect worlds, prices match the true value people receive. “Value” is the tricky part because that can be intangible and volatile from genotype to genotype and from segment to segment. The measure of value then is derived from both differentiation of the product (the value added beyond what competitors can do) and often by fundamental return on investment (ROI) calculations. Knowing what the market will bear is a first step, to be whittled down by …

Competition pricing

Knowing what your competitors charge for the same set of features is imperative, and is one of two baseline prices. All other things being equal (which they better not be), you cannot charge significantly more than your competitors. Knowing this baseline price will also help you understand and calculate the value of your differentiation. However, there are times when charging a higher price than your competitors is warranted. In the war story I related above, I had also consolidated our brand and roped several key strategic partners, which are non-product differentiations. I raised our prices while our competitors were lowering theirs. We grew and they died.

Cost plus

You have to make a buck, and it has to be more than what safe investments in mutual funds would return. Setting your minimum profitability goals and knowing your true cost for delivering your product allows you to set a cost+ baseline price. If this price is higher than your value price or significantly higher than your competitors, you must lower your costs, build more differentiation or quit the game.

Survey your market to discover your value and leverage. There are ways to find valid price points via surveying (when done right, people will not just pick the lowest price). Then if in doubt, price to the value you can prove or justify if it is higher, for it is easy to test lower prices through discounting.