Prices: The Myth of the Ideal Margin

The search for the ideal margin is an aim that keeps a lot of business owners up late at night, but this kind of reasoning does not always help them be more profitable.

Thursday, August 23, 2018

In general, those who ask themselves what price they should set for their product, start from an incorrect premise: using the cost as a starting point. 

Ariel Baños, expert economist in pricing strategy and founder of Fijaciondeprecios.com, explains that calculating sales prices based on the associated cost and applying the margin you want to obtain, is a paradigm that must be broken. 

Baños' suggestion is "... to completely change the axis of the analysis, and ask ourselves: What price allows me to maximize the margin in each case?"

Put in this way, the question focuses on two key aspects of price management:

1- The definition of the price precedes the cost
2- The price can not be the same for all customers

The definition of the price precedes the cost

Prices define costs, not the other way around. Do not put the cart in front of the horse.  Deciding on the sale price will allow us to find out what level of costs the company can incur in order to profitably sell a product. Not the other way around. 

Given that it is a purely internal variable, the cost could never be the main determinant of prices, since it tells us nothing about the value of the product as perceived by customers, nor does it take into consideration our competitor's prices.

For example many shops selling gift items, set price levels that are greatly attractive to customers, such as $49.99, and then start to look for products and suppliers that can provide interesting options, at a cost that makes selling at that price profitable.

The price can not be the same for all customers

Not all customers are the same, nor do they value the company's products in the same way. Therefore, why define a single price for the entire market? 

Companies must segment prices. There are several instruments to selectively adjust prices. Thus, it is increasingly common to see the implementation of price segmentation strategies, with a large dose of creativity and ingenuity.

In addition, from this new suggested approach, the calculation of margin will always be based on sales. This format better reflects profitability, by relating it to the sale price, and also allows for a better evaluation of discounts and adjustments, whose base is always the sale price.

Now that you know this, instead of wondering what the ideal margin is, ask yourself, what price allows me to maximize the margin in each case?

See more on Fijaciondeprecios.com (In Spanish)

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The myth of the ideal margin
By Ariel Baños
President and founder of FIJACIONDEPRECIOS.COM

The search for the ideal margin is a goal for most companies. However, this reasoning does not help them be more profitable.

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