Many business leaders make the mistake of believing that cost is the main factor when it comes to setting the price for their product or service. A common practice, for example, is to just take your cost and add a certain percent on top of that. Simple enough, right? But by doing this, you could be leaving significant profit on the table. Why?
The truth is that cost and price are unrelated. The market sets the price; it’s what your customers will pay for the value you provide. But price is also a strategic tool you can deploy to either maximize your profits or drive the growth of your business by gaining market share. Even if you are the low-cost provider in your market, that doesn’t mean you should also be the lowest priced provider.
Think about Southwest Airlines. They were founded on the notion of being the low-cost provider in their industry. They keep the frills to a minimum and only fly routes where they can ensure they can attract the number of passengers they need to fill up their airplanes.
As a customer, you can definitely pay less by flying Southwest than other airlines–but usually only if you book far in advance and are willing to fly during non-peak hours and days. By offering lower process during those flights, Southwest is ensuring that they get a full flight. But for last-minute bookings, or even on routes that are in high demand, you might find that Southwest charges just about what every other airline does. They understand how to set their prices strategically to help them maximize their profits at all times.
And it’s amazingly effective. When you think about how often the airlines seem to run into financial difficulty, consider the fact that Southwest has been profitable for 45 years in a row. That’s not a typo.
What Southwest does as good as anyone is to combine being the low-cost provider with setting their prices in a way that they both ensure full flights and that they are always making money on those flights.
That’s the kind of flexibility you have when you understand how cost and price are unrelated. If you are trying to rapidly grow the market for your product or service, for example, you might be willing to make less margin by setting lower prices because your goal is to grab as much of the market as you can. In either case, ensuring predictable profits or driving growth, lower costs can be used as a tool and it deserves a conscious choice as to which you use.
But, as I have mentioned in another article, it might also be time to raise your prices because just raising your margin a few percentage points could dramatically grow your bottom line.
It all depends on your goals for the business.
The goal, therefore, is to go beyond the simplicity of just tacking a few percentage points onto the cost of your product or service and begin to realize how price can be a competitive weapon for you–especially when you can also keep your costs under control.