Episode 92: Pricing Strategy For Success – Part 2

Episode Overview In this second episode of the pricing series, hosts David and Eric bridge from pricing theory into practical strategy and application. They explore the critical differences between cost-plus and value-based pricing, discuss price elasticity, and provide actionable frameworks for optimizing pricing in middle-market private companies. Key Topics Covered 1. Marginal Buyer Theory Recap The last buyer-seller transaction indicates market pricing potentialPrices function as market signals about resource valueIgnoring the marginal buyer leaves money on the table 2. Price Elasticity of Demand High Elasticity: Small price changes cause significant market share loss (e.g., hotdog industry – one penny change = major impact)Low Elasticity: Price changes have minimal impact on customer retentionRevenue optimization: Selling at 2x price with only 5% customer loss increases overall revenue and profit 3. Cost-Plus Pricing When It Makes Sense: Regulated industries (utilities, government contracts)Commoditized productsNew product launches (to establish break-even baseline) How to Calculate: Add all direct costs (materials, labor, freight)Allocate indirect costs (rent, depreciation, admin)Calculate total unit costApply markup based on contract requirements or industry standards Limitations: Focuses energy on cost side, not demand sideMisses shifts in market dynamics and pricing powerLeaves value on the table from marginal payersDoesn’t account for subjective customer value 4. Value-Based Pricing Core Principle: Maximize profitability by capturing the value created for customers Implementation Steps: Identify the specific problem your product/service solvesQuantify the cost of the problem to your customer Lost salesProduction inefficienciesHigher operational costs Calculate economic value created What would alternative solutions cost?What’s the total economic benefit? Set pricing below total value to ensure customer benefit Example: If your solution creates $100K/year in valuePricing at $100K = customer breaks evenPricing below $100K = customer realizes net benefitConsider multi-year value (Year 1: break-even, Year 2+: 100% profit to customer) 5. Pricing Optimization Strategies For Established Businesses: Run pricing experiments to optimize revenue and profitTest different price points carefully (consider elasticity)Create multiple proposal versions with different pricingDifferentiate by geography or market segmentTrack conversion rates and customer response Key Insight: Value pricing aligns your interests with customer interests – if you’re not bringing value, you shouldn’t be in business together. Action Items for Listeners Complete the homework from Episode 1 analyze your data using marginal buyer theory Quantify the economic value your product/service creates for customersCalculate what alternative solutions would cost your customersBegin pricing experiments in your business (if appropriate for your industry)Prepare for Episode 3 Coming Up Next Hourly pricing vs. value-based pricing for servicesComprehensive pricing strategy frameworkPutting all the pricing concepts together Key Quotes “A price is not something you set, even though yes, you do set them, it’s more of a signal of what the market is saying about the value of certain resources.” “Value pricing always aligns ourselves to the interest of the customer and the client. If we’re not bringing them value, then what the heck are we doing?” “When all of your pricing energy is going to the cost side, you’re paying less attention to the demand side.” Resources Episode 1: Pricing Theory & Marginal Buyer ConceptEconomist referenced: Ludwig von Mises