Set price from the pricing rules and the three models

1. Which lever to pull first

Suppose you could double one thing in a business and leave the rest alone: the number of new customers each month, the number of times each customer buys, or the price. On paper each one doubles the most revenue the business could reach. What each does to profit is another matter.

The starting business, as stated here. Only advertising and delivery costs are counted in these figures; real businesses carry other costs, and the comparison is offered as a model that helps either way, not as a full account.

Starting figure	Value
New clients a month	30
Monthly churn	33 percent (three months)
Price	$100 a month
Clients	100
Revenue a month	$10,000
Profit a month	$2,000, a 20 percent net margin
Cost to acquire a client	$100
Lifetime revenue per client	$300
Lifetime gross profit per client	$150, a 50 percent gross margin

The results, on the same two costs only:

Double this	What moves	Clients	Revenue a month	Profit a month	Net margin	Profit against the start
New customers, for the same advertising	60 new a month; acquisition cost $100 to $50	200	$20,000	$7,000 (steps) / $4,000 (table)	35%	3.5x
Purchases, so clients stay twice as long	Churn 33% to 16.5%; lifetime revenue $300 to $600	200	$20,000	$7,000	35%	3.5x
Price, with nothing else changed	$100 to $200 a month; gross margin 50% to 75%	100	$20,000	$12,000	60%	6x

More customers. Twice the clients for the same advertising spend halves what each one costs to win. Revenue doubles and, to keep it simple, delivery costs double with the clients, but the acquisition money you did not have to spend drops to profit: $2,000 becomes $7,000.

More purchases. Buying twice as often, or staying twice as long, in effect halves churn, and the average client stays six months instead of three. Delivery per client doubles with it, $150 to $300 over a lifetime, while the $3,000 a month spent winning clients stays where it was. At the plateau, 200 clients paying $100 bring in $20,000; delivering to them costs 200 times $50, or $10,000; with acquisition the costs come to $13,000, and $7,000 is left.

A higher price. The same clients pay twice as much for something that costs the same to deliver. Lifetime gross profit per client rises threefold, $150 to $450, because lifetime revenue goes from $300 to $600 while delivery stays at $150. Costs stay at the starting $8,000 a month, so $20,000 of revenue leaves $12,000 of profit.

The pick is price: double it, keep everything else as it was, and profit rises six times. The comparison was built to explain a pricing study; that study's figures are on SOP 77 — Run the ten pricing plays that add profit now, section 1, and are not repeated here.

Flag: the plateaus. Client counts come from dividing new clients a month by monthly churn. 60 at 33 percent is given as 200; the division gives about 182. 30 at 16.5 percent is also given as 200; the division gives about 182. The starting 100 is stated rather than worked out; the same division on 30 and 33 percent gives about 91. The table above uses the given 200 and 100. This page does not settle which reading is right.

Flag: the first option's profit. The worked steps give $7,000 of profit a month at a 35 percent net margin; the results table beside them gives $4,000 against the same 35 percent, which on $20,000 is $7,000. The steps call $4,000 the extra profit from simply doubling the business; on the starting figures, doubling gives $4,000 of profit in all, $2,000 more than before, and it is that $4,000 plus the $3,000 saved on acquisition that makes $7,000. The table above shows both. This page does not settle which reading is right.

Flag: the new price. The third option's table prints the new price as "$1=$200/mo". Doubling $100 gives $200, and the table above uses $200.

2. The three pricing models

People usually set a price by checking what everyone else charges. That is how you end up breaking even and burning out, running what amounts to a nonprofit without any of its perks. The downward cycle that copying produces is on SOP 2 — Set a price from the value gap, not from competitors, section 2.

There are three big models.

Cost plus. Add up your costs and put a margin on top, picked more or less at random.

• For it: easy to understand, and your costs are covered.
• Against it: the buyer who would pay more because they need it more earns you nothing extra. Costs change, and you do not always know every cost in advance. Buyers cannot see your costs, so those costs carry no weight with them.

Competitor based. Charge the average of what everyone else charges.

• For it: simple, and it might sit closer to what the market will pay.
• Against it: you are copying. The price rests on other businesses and their customers rather than on yours, and a shoe made for somebody else's foot is hard to walk in.

Value based. Price on what the customer is willing to pay, not on what competitors are willing to charge.

• For it: what a customer will pay for your product today looks very different from what they will pay once you have made it more valuable to them. Make something a customer actually wants, rather than charging more for what they can buy cheaper elsewhere, and you can charge two, three, four or five times market rates, or more. New customers may well pay more than your current price. Keep adding value and you can keep raising the price, and the model pushes you to do exactly that, because value is what lets you charge more. So you talk to customers far more, to learn what they want and build it, and you make money when you get it right.
• Against it: the aim moves from winning the most customers to giving the most value to each one you win. That takes more work, and a different kind than most owners are used to: thinking as well as doing.

Value based is the model to be on. How to find the value-driven price is SOP 128 — Test price with a step size and a cadence. How far above the market to sit is SOP 2 section 5.

3. The rules: why and when to raise

The rules in sections 3 to 5 run in the order they are given. They are offered as one owner's beliefs, set down as the foundation the pricing plays on SOP 77 are built on.

Raising prices makes money in two ways. You make more gross profit on each customer, and with fewer customers you spend less delivering, so revenue rises while costs fall. In one gym, prices went up threefold, from $99 to $299, and 30 percent of customers left: 200 at $99 became 140 at $299. Revenue more than doubled, costs fell 30 percent, and the effect on profit was much larger.

Price for the most money, not the most customers or the biggest first sale. If customers buy different things from you, or the same thing more than once, the price has to allow for it: you want the price that earns the most across the customer's lifetime, not the highest price a first purchase will bear. The target moved from the highest price you could get someone to buy at to the price people will keep paying.

Higher prices win fewer new customers but often make more money. Double a price from $10 to $20 and you often do not lose half your conversions. Every price increase rests on that.

A high close rate means the price is too low. If you want to make more money and you close more than 50 percent of sales consistently, there is room to raise.

Full capacity means the price is too low. In the same way, if you want to make more money and you have hit capacity, there is room to raise.

Fixed capacity, and full: raise. An artist who physically cannot paint more than 10 pictures a month has a fixed capacity. If they all sell every month, the price has to go up.

4. The rules: how far to push

Keep raising until the extra money from new sales no longer makes up for the sales you lose. More noes, more money. When the first no comes, be willing to hold off before moving the price back. Drop from a 50 percent close rate to 30 percent while doubling the price and you make more money, but you hear no 40 percent more often than before, so you have to be able to stomach it. Some markets are sensitive to price and some less so, but 9 times out of 10 a price rise earns more in profit than it costs in lost sales.

A higher price usually means more value. To sell at a higher price, make the product better to justify it: the bigger the increase, the bigger the added value. What a higher price does for the client is on SOP 2 section 3.

Hearing no more often does not mean less money. On paper a higher price brings fewer customers and more money, and that is often true. What new and experienced owners alike tend to forget is that more money from fewer people means hearing no from far more people. Hearing no is unpleasant, so much so that owners often give in and cut the price to collect more yeses rather than more money.

How to tell the price went too far. Sales stop, or people start complaining about the value they get for the cost. That is measured objectively with NPS scores.

5. The rules: customers, belief and billing

More than one type of customer needs more than one price. Customers differ in what they will pay. You probably have two or three customer avatars, and it is not uncommon for one of them to be willing to pay 5 to 10 times what another will. A more advanced pricing model allows for that, to get the most revenue across the whole customer base; typically it means more prices and more levels of service to fit each group's preferences and spending power. It is an advanced strategy and needs the operational ability to deliver at more than one level. With several tiers, make sure each customer knows which one is theirs, and name each tier after an aspirational title the customer wants for themselves. Building tiers out of what you sell is on SOP 72 — Generate tiers and downsells from the quality vectors, section 6.

Believe in your price. Work out what you would need to charge to earn the money you want, and be convinced the product is worth that; if it is not, improve it.

Bill less often to lose fewer customers. People cancel more often when you bill them more often; a long gap between bills leaves more time to deliver value. Billing daily brings far more churn than billing yearly, so bill as far ahead as you can. The explanation offered, as a theory and not a finding: a customer judges you on the value inside the last billing period, not the whole relationship. Paid $5,000 a month, you make a client $60,000 in the first month and think you have paid for yourself for the year; they think it was a good month, and if the next month makes them $0, they cancel. Longer periods, on this theory, also bring more qualified customers, because they pay for longer up front. The churn data on yearly billing is on SOP 77 section 5.

Show the price small, bill it large. This rule is on SOP 78 — Switch to twenty-eight-day billing and collect a second card, section 4.

Bill the way you deliver value. Separate one-time value from ongoing value; many mistakes come from mixing them. Sell information and accountability at one price and the information will likely be underpriced and the accountability overpriced. Charge a one-time fee for the information and a smaller ongoing fee that fits the smaller ongoing value of the accountability. The day after someone learns a thing, access to it is worth close to nothing, and a buyer still paying a price set for not knowing it will likely stop. Tie price to the value created. The same split, with other examples, is on SOP 74 — Price continuity against upfront cash, section 8.

Charge as much as you can while customers stay happy. The gap between price and value is customer surplus, which some call goodwill. The size of that surplus typically governs the strength of your word of mouth and how many repeat purchases your customers make. The preferred way to handle it is a premium price that pays for a far better product and exceptional value: surplus for the customer, net profit for you. The gap between price and value is on SOP 2 section 1.

6. What this page does not decide for you

• Where to stop raising. The rules give more than one signal: new money no longer covering lost sales, sales stopping or complaints about value, and customers staying happy. None is ranked above the others.
• What a higher price does to your customer count. Section 1's price option holds the customer count still; the rules in section 3 expect fewer customers at a higher price. Your conversion at a new price: not established on this page.
• Your other costs. Section 1 counts advertising and delivery only; this page does not rework the comparison with anything else.
• How many tiers. This page gives no figure for how many price tiers to offer.

7. The checklist

Question	The answer
Which lever moves profit most	Price: doubled with nothing else changed, 6x profit, against 3.5x as stated for doubling customers or purchases (advertising and delivery costs only; section 1 flags the first option's profit)
Which model to price on	Value based: what the customer is willing to pay
What to maximize	Money over the customer's lifetime, not customers or the first sale
Signs the price is too low, if you want more money	Closing over 50 percent of sales consistently; full capacity; a fixed capacity that sells out
How far to push	Until new money no longer makes up for lost sales; expect more noes
Signs it went too far	Sales stop; complaints about value for the cost, measured with NPS scores
More than one type of customer	A price for each; with tiers, one each customer can recognize as theirs
How often to bill	As seldom as you can
One-time and ongoing value	Billed separately
How much to charge	As much as keeps customers happy, leaving them a surplus

8. What this page does not cover

The pricing-study figures are on SOP 77 section 1, and the ten plays built on these rules are the rest of SOP 77. For testing a price, its step size and how often to move it, go to SOP 128 — Test price with a step size and a cadence; for reading price off the close rate, go to SOP 224 — Set fractal price tiers and read price off the close rate. The gap between price and value, the downward cycle of copying competitors and how far above the market to sit are SOP 2 — Set a price from the value gap, not from competitors.

Price-discrimination and consumer-protection rules are not covered on this page.