Part II · Chapter 4 · Engine · lesson 6

Pricing is positioning, not arithmetic

12 min

A joiner works out that a fitted bookcase costs 340 in materials and two days of his time, adds a third, and charges 900. Down the road another joiner builds the same bookcase out of the same wood and charges 2,600. He is booked until spring.

The cost was identical. The cost was never the question.

Cost sets a floor. Below it you lose money on every sale and the volume makes it worse.

Above the floor, cost tells you nothing. The price is decided by what the buyer believes the alternative is — doing without, doing it themselves, or buying it from someone else — and by which of those alternatives they are actually comparing you to.

Pricing is therefore not arithmetic. It is a claim about which shelf you are on.

Three ways people set prices

Cost-plus. Work out what it costs, add a margin. Defensible, easy to explain, and it hands your pricing power to your suppliers. Every business that has never thought about pricing does this, and most of them think it is the only method there is.

Competitor-matched. Find out what the others charge and sit near them. This is a reasonable default in a market where buyers can compare like for like, and it quietly concedes that you are like for like.

Value-based. Estimate what the thing is worth to this buyer, and price against that. It requires knowing something about the buyer, which is why it is rare, and it is the only one of the three where the price can be many multiples of the cost without anybody feeling cheated.

The second joiner is not doing better arithmetic. He is being compared to a piece of furniture rather than to two days of labour.

Something people say

“Price it low to get customers, then raise it later.”

Why it spreads: It works often enough to stay alive, it feels safe, and the first half of it is easy while the second half is somebody else's problem next year.
The part that is true: In markets where the winner really does take most of it — where buyers coordinate around whichever option others already use — buying early share at a loss can be the correct move, and some very large companies did exactly this.

Where does the reasoning most often break?

Price is a position, and positions have costs

Every price implies a customer. Halve it and you are not the same business at a lower price — you are a different business, with a different buyer, a different service expectation, and a different set of competitors who were already there.

What would you do

You and one other person build websites for small firms. The going rate in your town is around 4,000 for a site. You charge 4,200, you win roughly one in three of the projects you quote for, and last year you cleared just enough to pay yourselves modestly.

Two things changed this quarter. A cheap offshore studio started quoting 1,400 for what buyers believe is the same thing, and one of your past clients — a dental practice — told you the site you built pays for itself every eleven days in new appointments.

Optimising for: Survive the next twelve months as an independent two-person studio, with the owners still able to pay themselves, rather than maximise the largest plausible outcome.
You cannot know: Whether the cheap studio can actually deliver, and how long buyers take to find out
How many of your past clients could make a claim like the dentist's, and how many are just polite
Whether your win rate at a higher price would be one in five or one in twenty
How long your savings would cover a quarter with two projects instead of six

Hold at 4,200 and wait for the cheap studio's clients to come back disappointedCut to 2,600 to stay in the conversationReprice to 11,000, aimed only at firms who can name what a customer is worth to themMove to a retainer: 900 a month, ongoing changes included

The uncomfortable arithmetic of a discount

A ten percent discount on a product with a forty percent gross margin requires a thirty-three percent increase in volume to stand still. Not ten. Thirty-three.

The reason is that the discount comes entirely out of the margin, not out of the price. You gave away ten of your forty. To make the same total contribution on a margin of thirty you need to sell four units where you sold three.

Check

Same business, forty percent gross margin. A ten percent price rise costs you customers. What share of unit volume could you lose and still be no worse off?

About ten percentAbout twenty percentNone — any lost customer is a lossAbout fifty percent

Worth remembering

Cost sets a floor under a price and says nothing about where the price should be above that floor.
The three common methods are cost-plus, competitor-matched and value-based, and only the last one can price at many multiples of cost.
A low introductory price recruits the customers most likely to leave when it rises.
On a forty percent margin, a ten percent discount needs roughly a third more volume to break even.
On the same margin, a ten percent price rise breaks even after losing about a fifth of unit volume.