Pricing Strategy: Pricing Inputs Example

This is part 3 of our series on Pricing Strategy. Previous segments are available on our archives page.

Pricing Inputs (Example)

Now that we know what inputs we should consider in coming up with a pricing strategy for our product, let’s take a look at how that could play out with Doug’s Desserts, a hypothetical company that sells its baked goods online and also has an online subscription service that provides customers with recipes and tips.

Cost of Goods Sold (COGS), Plus a Margin

Doug’s Desserts has a number of costs associated with producing its baked goods, like chocolate chip cookies, that are mailed to customers as well as the online subscription service.

Cost Chocolate Chip Cookies

(per dozen)

Online Subscription Service

(per monthly customer)

Ingredients $0.75
Facility $1.00
Labor $2.00 $0.75
Online hosting $0.25 $0.25
Total $4.00 $1.00

 

Suppose I want to make a 50% gross margin on each product. Then I would need to sell cookies for $8.00 per dozen and online subscriptions for $2.00 per monthly customer.

Target Revenue Divided by the Number of Expected Customers

At this point in my company’s life, my goal is to have $5,000 in monthly revenue and 1,000 customers each buying at least one dozen chocolate chip cookies per month, so I need to sell cookies for $5.00 per dozen to meet my target. I aim to have $10,000 in monthly revenue from 10,000 customers for my online subscription service, or $1.00 per monthly subscription.

Price of your Competitors

My local Safeway sells 50 chocolate chip cookies for $5.00, or $1.20 per dozen. But, the quality of ingredients and taste of my cookies is vastly superior to Safeway’s, so they are not a true competitor! This online review says that the best store-bought chocolate chip cookies in America are Tate’s, selling 14 cookies for $5.99, or $5.13 per dozen.

Cook’s Illustrated (my favorite place for recipes) sells their standard online membership for $34.95 per year, or $2.91 per monthly customer. But they have an entire test kitchen that they use to test hundreds of versions of each recipe, so their recipes and tips might be better than what I can offer. There are also lots of free options out there that make their money off of advertising.

Value of your Product to your Customers

Buying chocolate chip cookies provides my customers the benefit of saving their time from having to shop, bake, and clean-up, plus the delicious taste and quality of my cookies compared to their own (or my competitors). They have ingredient costs similar to mine, but presumably a little more expensive since I can buy in bulk. Let’s assume my consumers’ ingredients cost 25% more per dozen, or $5.00 per dozen. And let’s assume that each customer bakes two dozen cookies once per month, it takes two hours to shop / bake / clean-up, and that their time is worth $5.00 per hour. That means there is a time savings of $10.00 per two dozen, or $5.00 per dozen. So the total value to the customer is $10.00 per dozen (before considering the superior taste and quality of my cookies).

The online subscription also saves my customers time. Let’s assume two hours a month are put into meal planning, and my recipes / menus could cut that time in half. At $5.00 per hour, the value to my customer is $5.00 per monthly customer (before considering other benefits like impressing their family and friends with such delicious food).

Summary

Pricing Input Chocolate Chip Cookies

(per dozen)

Online Subscription Service

(per monthly customer)

COGS, plus margin $6.00 $1.50
Target revenue $5.00 $1.00
Competitors $5.13 From $0.00 to $2.91
Value $10.00 $5.00

 

The theoretical value that my products provide my customers outweigh the other inputs, so that gives me a good idea of how much I could potentially charge. But until I’ve sold my product and talked to customers, these values are a little fuzzy.

I’ll price my chocolate chip cookies at $7.00 per dozen, knowing that I’ll have work to do explaining to customers how far superior my product is compared to my competition. I’ll price my online subscription service at $2.00 per monthly customer because I am not sure yet if my value will exceed that of my competitor’s.

This research gives me a good starting point on my pricing. Tomorrow I’ll talk about what you can expect to happen when you change your prices via the concept of the price elasticity of demand.

Recipe of the day: Cook’s Illustrated Perfect Chocolate Chip Cookies (free trial / subscription required; I do not receive any compensation for this link)