6 min read
As a social innovator, you have probably spent a lot of time developing your product or service to generate positive social impact, but have you considered how to price them to maximise your impact?
Here are some tips we have for you straight from our Social Investment Toolkit:
To decide on how to price your goods and services there are three main questions that you should use to guide you in your pricing decision. These three questions will tackle the following issues in pricing, marginal cost, affordability, and competition.
What is the cost of one extra unit of your product or service?
This refers to the raw materials, labour costs and other costs that would be spent if you were to produce an extra unit, not the overhead costs which you must spend anyway such as the rent on your office. Economists call this your marginal cost of production, or we can call it your unit cost. If we take the example of SolaRise, a company investing in providing renewable energy, this would be the cost of the materials for one Solar Kit, combined with the cost of shipping the unit to Tanzania, and then the cost of delivering it to local stores for sale, and the cost paid to the retailer for stocking and selling the Kit. These costs are only incurred if the Solar Kit ships.
At the very minimum, your price must be above this marginal cost. If the price isn’t above the marginal cost incurred, then you are losing money every time you make a sale, which is unsustainable. In reality, you need to be pricing much higher than your marginal cost to make real financial gains. You should charge a margin above the unit cost, ensuring that you can generate enough profit to cover all of your overhead expenditures and also provide a financial return for investors.
What can your customer afford, or is willing to pay, for your product?
Once you have figured out what minimum price you can afford to charge you need to consider what price your customer is able and willing to pay. Sometimes you can only find this out through market studies, or actual market observation. Although, often you can make an educated guess based on what you know about your customers. You first need to work out what they are currently paying, in the absence of your product or service. This is your ceiling price, meaning, the maximum you can charge.
If we continue with the example of SolaRise, they know that their customers earn only $4 a day, and spend a maximum of $1 a day on kerosene for lighting and heat. This means that the most they can afford for lighting/heat services is $365 per year. Since a Solar Kit costs $200 to produce and distribute, and they need to charge more than this to cover their cost, the price for a Solar Kit must be between $200 and $365. These numbers are quite a range in price, so you need to do a bit more research and crunch some more numbers to reach the final price you want to charge.
What is your customer currently paying for a competing product or service?
If you were SolaRise and you had just calculated that a Solar Kit must be priced between $200 and $365 you’d need to find the correct price by looking at your competitor’s price. This would ensure you are not pricing too low or too high in relation to the market prices. It is important not to price your product or service higher than the competition, especially if the competition is more established. Therefore it is essential to find out who your competition is, and discover what they are charging for their products and/or services.
If SolaRise had a competitor who was selling Solar Kits for $250, for example, that is likely to be the highest price that they can charge too. To build market share, particularly for a new product, you need to be cheaper and better than others doing something similar. Note that ‘Competition’ doesn’t necessarily mean another business selling a similar product. Your competition is whatever else your customer is currently paying for in your absence. For example, in the case of SolaRise their customers are paying for low-quality candles to provide light, and kerosene for basic fuel. The competition for SolaRise is not another solar company, but the use of kerosene.
Many social entrepreneurs hope that their customers will pay more for their service relative to the competition because their business is ‘social’. Perhaps your business has a more eco-friendly supply chain or employs a certain kind of worker such as ex-offenders or those with disabilities. Unfortunately, in our experience, customers are rarely willing to pay more for services from social businesses just because they are social. You should expect to have to price at the same level or lower than your competition and offer a much better quality of service. Only then will your customer risk switching to you. SolaRise, for example, cannot afford to price higher than the cost of kerosene that their customers are already paying for, even if the quality of the solar lights is significantly better than kerosene candles. The team needs to make the case that their product is not only much better than the competition, but also much better value for money.
To summarise, you have three steps in the pricing process. First determine your marginal cost, the price of producing a unit will determine the minimum price you can charge. Your second step is to find out how much your customer is able to and willing to pay in order to determine the maximum price you can charge within an affordable range for the customers. Finally, find out who your competition is and how they are pricing their goods and/or services to ensure you are pricing competitively and convincing the customer that your product/service gives better value for their money.
★★★ Investor Tip ★★★
Don’t price too low It’s easy to get the pricing decision wrong. One of the reasons is that many social entrepreneurs come from the charity sector, which typically charges on a ‘cost recovery’ basis: in other words, few social sector organisations feel comfortable or able to charge anything beyond what it costs them to produce and deliver the product or service. This lack of comfort with charging a ‘profit margin’ on top of the raw cost means that many social ventures never build up any cash reserves, and are always at risk of insolvency. Many make the mistake of only charging enough to recover the marginal cost of production, but not to recover any overheads. This is not a sustainable pricing strategy. If in doubt, start with a higher price. You can always lower your price if you’re not getting enough demand. But once you’ve set a price, it’s very difficult to raise it as you will have set up customer expectations.
Resist the temptation to set a low price to acquire customers quickly: customers do not take kindly to businesses that set a price and then raise it. Please note that this is not the same as offering customers a ‘trial period’ where they can get used your product for free (or lower cost) for a period of time, as long as you are clear from the start that they will pay more once the trial period is over.