We all value things differently. We all have a different perception of the value of any product or service. So we all have a different maximum amount we are willing to pay for a particular product or service. It’s our personal judgement call – and it’s entirely subjective. “So what?” you might be thinking. Well, this seemingly tiny observation has a profound implication. You see, it means that whatever price you are currently charging, that price is WRONG!
Is that a big enough implication for you? Actually, I probably need to clarify that statement that your price is wrong. Let me be more precise. If you have a single price for your product, then that single price is WRONG… no matter what that single price actually is.
You see, having only a single price causes you to lose out in two different ways….
– For some customers that price is too high – so they don’t buy, and you lose them as a customer.
– And for other customers that price is too low – so you end up charging them less (and earning less profit) than they are willing to pay. Which means you lose again.
Economists call the amount by which you lose in this second scenario the “Consumer surplus”. So one of the keys to dramatically improving your profits is to claw back some of this consumer surplus by charging different customers different prices.
Let’s now look at the maths.
Imagine that you sell widgets that cost you £1 each and for which there are three potential customers: A, B and C.
– Customer A is willing to pay £4
– Customer B is willing to pay £3 and
– Customer C is willing to pay £2.
If you set a single price at £2, the all three customers will gladly pay you £2. So you’ll make total sales of £6 and profits of £3.
If you set a single price at £3, then Customer C won’t buy. But the other two will gladly pay you £3 each. So you’ll make total sales of £6 and total profits of £4.
If you set a single price at £4, then only Customer A will buy. So your total sales will be £4 and your total profits will be £3.
The MAGIC PRICE is the price at which you make the most profits. So in this example the MAGIC PRICE is £3 – since at that price you make £4 in profits – which is 33% higher than at any other price.
Now £3 is the MAGIC PRICE… because there is no other single price at which you can make higher profits. But we also know that: Customer A is willing to pay £4, Customer B is willing to pay £3 and Customer C is willing to pay £2.
So, if instead of charging those three customers all the SAME prices, we charge them the full price they are willing to pay, then our total profits will be £6. Customer A will pay £4, Customer B £3 and Customer C £2, so total sales are £9, with costs of £3. Which is half as much again as the £4 profits we made at the magic price.
Now it’s vital to recognise that there is nothing fishy or special about the numbers in our example. YES, I’ve kept the numbers as simple as possible. And YES, the real world is much more complicated.
But those complications do nothing to alter the fact that if you can find a way to charge different customers different prices – so that they each pay what they are willing to pay – then you will ALWAYS make more profits than you do by using any single price… even if that single price is your magic price.
In our example we made 50% more profits by switching from the magic price to charging each customer the full price they were willing to pay. In your business the impact could be more or less than 50%. But there WILL be an impact. Charging different customers different prices WILL increase your profits… and probably by a lot!
Economists call this “price discrimination” – but we prefer the Plain English description of charging different customers different prices, since that’s what it actually involves.
But how do you actually do it? Because it actually dies work, and it’s not illegal, or immoral (maybe fattening)
Well, the key is being much more creative about pricing.
In future blogs) we’ll look at:
– exactly how you create different versions of your products and services,
– how you price those different versions,
– how you present (and explain) them to your customers, and vitally important,
– the order in which you present them to your customers.