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Brief Explanation Introduction

How can you make the most out of your product or service?

There are three questions that you should use to guide you in your pricing decision.

→ Marginal Cost

What is the cost of one extra unit of your product or service? 

Here we are talking only about 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 (e.g. the rent on your office). Economists call this your marginal cost of production, or we can call it your unit cost.  

At the very minimum, your price must be above this marginal cost. If it isn’t, then you are losing money every time you make a sale, which is unsustainable. But actually you need to be pricing much higher than your marginal cost. You need to charge a margin above the unit cost, such that you can generate enough profit to be able to meet all of your overhead expenditure and provide a financial return for investors.  

How high should this margin be? It depends from product to product. If you are selling a lot of a product, you can afford a lower profit margin because you will make up the total profit through a high volume of sales. Products that sell infrequently will need a much high profit margin per unit.  

→ Affordability

What can your customer afford, or is willing to pay, for your product? 

The next key constraint on your price is what your customer is able and willing to pay. Sometimes you can only find this out through market studies, or actual market observation. But 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. 

→ Competition

What is your customer currently paying for a competing product or service? 

You cannot price higher than the competition, especially if the competition is more established. So it is essential to work out who is your competition, and what are they charging? 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 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 to offer a much better quality of service. Only then will your customer risk switching to you.  

Case Study

For SolaRise, it 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. SolaRise knows that its 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. They, 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. 

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. 

Tips

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 use 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. 

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