Understanding price, cost, and value

- Perhaps the biggest mistakes in pricing happen when you confuse the meaning of cost, price, and value. Let's review these so you avoid these pitfalls. Let's use this for our example. Baseball is a very popular sport in the U.S., and this of course is the ball used in that sport. Each year the professional baseball league here in the U.S. uses about 900,000 of these. Wow. So let's start with this simple question.

What is the cost of this baseball? Well, the cost is what the manufacturer must put into the ball to make it and sell it. That includes all the material cost, labor, shipping, and selling costs. Let's say on average that's about $1. Now that wasn't too hard. So let's ask the next question, what is the price of this baseball? Price is defined as the amount of money a consumer must pay to take ownership of the ball, in other words, to buy it.

So when pricing, many people think there's a relationship between the cost of the baseball and the price of the baseball. To most people's surprise, there is actually no linkage whatsoever between the cost of a product or service and its price, at least from the customer's point of view, which, by the way, is most important in marketing. The average price of a baseball today is around $6. Now hold on. I know what you're thinking. You're thinking there's no way you would ever price your product below your unit cost.

Well, that's not completely true. There are a few occasions where you might price something below the cost to produce. Not often, but it can happen. My point is this. When you set prices based on cost, you're likely to end up with an artificial price point that doesn't resonate with the customer. This pricing approach is often called target margin pricing. You take the cost of your product and add a margin to satisfy some profitability goal. Hey, the truth is your customers don't care about your costs.

So here's the final question. What is the value of this baseball? Well, it depends on who's assessing the value. If this was the baseball that, say, your son hit to win the game, then it's really valuable. And by the way, this is the ball that my son hit to win a game, so to me, its value is really high. But for you, not so much. Now what is the relationship between price and value? Remember, a price is a piece of information.

It's a signal to the consumer about the value. Consumers, including B2B customers, equate price as an approximation of the value they're likely to receive. If they perceive the value to be higher than the price, they'll buy your product or service. If perceived value is equal to price, then they might buy your product. And if value is less than your price, they won't buy your product. So look at your prices and ask yourself how are they set? Were they based on the cost to produce the product or the value customers perceive in the product? You'll want to stick with pricing based on customer-perceived value, not your costs.