Learning to separate value from cost - Signal vs. Noise (by 37signals)

Learning to separate value from cost David 28 Oct 2005

10 comments Latest by John

Russell Beattie, like most people, feel bad about pricing something at its value instead of its cost:

Let me make an aside for a moment and say that I’m always fascinated by what I call “natural business people.” These are the folks that have absolutely no problem making money. If I buy something for $2, I have this vague sense of guilt when I turn around and try to sell it for $4, and even worse if I sell it for $6. It may be worth $6 now, but I know how much I bought it for and I feel bad. People like Bill Gates for example, don’t have this problem (remember the story of QDOS as the prototypical example).

This is as good a reason as any for Russell to get that MBA. And for would-be entrepreneurs in general to attend economics classes. While you can get the intellectual understanding on your own, it’s very hard to shake the gut feeling. And you need to shake it in order to drive a business from good to great (at least for one interesting degree of “great”).

(This is an abbreviated version of a Loud Thinking post)

10 comments so far (Jump to latest)

So Sad 28 Oct 05

Russell and his kind are so horribly misguided. Example: does this mean that if he paid $2 for something and it’s now worth only $1 that others are OBLIGATED to take it off his hands for the original price…? Sadly, for so many if this type, it means just that. “Ohhhhhh… the world owes me a livin’….”

jankowski 28 Oct 05

Along these lines, I was absolutely thrilled about the Exxon quarterly profits news item yesterday. The problem is not that they’re “gouging” — the problem is that gas was UNDER-priced in the US beforehand.

Mr eel 28 Oct 05

“Russell and his kind are so horribly misguided” Haw haw! What, does he belong to some misguided tribe of economists?

Just recently I’ve been thinking about how we price our work — I work for a web dev company. Because we started out small, we had fallen into the trap of thinking that we had to fight to get work. That meant giving quotes with small margins on them.

Enough of that though. We’re so busy, that instead of thinking ‘what can our customer afford’ in order to sell the job, we’re pricing based on what we think our time is worth.

We’ve lost a few small jobs as a result, but the upshot is we’re actually making better money.

Don Wilson 28 Oct 05

And you need to shake it in order to drive a business from good to great

Excellent point.

DC 29 Oct 05

Price is easy, and oh-so-computer friendly. Value has the implication of thought, and so will always be out of favor with buyers and sellers. Only where information and price intersect can we have value.

Value is a shift in thinking, not in pricing. Think about value and you’re almost forced to think about the value you bring to the table, in relation to the price you charge. Marketing starts with this shift from price, and cost to value. It’s a shift from internal focus to the person on the other side of the transaction.

It’s a similar shift from production based to user experience based business.

James Head 30 Oct 05

One of my favourite quotes…

A cynic knows the price of everything and the value of nothing.

(Oscar Wilde)

Tom Jarvis 31 Oct 05

I use to work for a consulting firm that specialized in pricing. In my experience price setting was often oversimplified. It is not uncommon for it to be based on one or a combination of the following: costs, customer willingness to pay, and/or competitors pricing. These are certainly factors, but effective pricing must begin with a good understanding of value from the customers perspective, and the interpretation of value across market segments (i.e., what one customer defines as value may be quite different than what another defines as value). Ideally, pricing should be based on differential value, or the value difference between your product/service and the next best competitive alternative in the market(s) you serve. Two key steps include: (1) understand value (i.e., what is the worth in $) within market segment (of course, one must determine these as well), and (2) setting the price (hint: it is not the same as value, but requires a solid understanding of value).

Once value is understood, there are many factors that can affect pricing, some of which might include: finding the right price metric (pricing based on something that closely tracks value), product/service structure, being a start-up, price sensistivities (e.g., fairness, customer experience, business strategy, etc.,).

If done right, it can be a very effective mechanism to dramatically improve margins, profits, and/or growth.

On the surface it looks like 37 Signals has focused on a previously underserved market segment (probably multiple segments), and established a price that generates valuable for their customers. Hopefully, it is helping them achieve their objectives (profitability, growth, etc.,).

Carlos 31 Oct 05

If anyone wants a basic view of economics, enough to be able to sleep at night knowing in the free market it’s okay to buy something for $2 and sell it for $6, read this book: http://www.amazon.com/exec/obidos/tg/detail/-/0465081452/

John 14 Nov 05

You’re invited to visit my Shopping site.