Thursday, April 7, 2011

Publishing Economics 0.2: Pricing Methods

     Before I take on the task of describing the traditional publishing (TradPub) houses' pricing methods and independent (Indie) publishers' pricing methods, I shall give a short primer in pricing methods.

     There are four pricing methods*:  1) Cost-plus pricing; 2) Target-return pricing; 3) Value-based pricing; and 4) Psychological pricing.

Cost-plus pricing.

     Figure up your costs of production and add a percentage. 
     This is the method used in the custom home-building trade.  Before he retired, my father built custom homes, so I have some experience with this.  In the housing bizz, the mark-up quoted ran 8 to 12 percent. 
     This is the method the board gaming industry used in the 1970s.  Their mark-up ran 325%.  It should have been 400%, but they saved money on their product testing by using unpaid labor.  (It's amazing how much you can get college boys to do when you promise them free pizza and beer.)

Target-return pricing.

     Figure up your costs of production, add to that your investment (or desired profit), take a WAG** at your sales volume for the next year, and divide the costs-plus-investment by that volume to get your unit price.
     To me, target-return pricing looks like an academic doctoral thesis and a practical goat-rope.  It assumes that you can 1) figure your costs of production accurately and precisely and 2) predict the future.  If I could do 2, I wouldn't be producing anything.  I would be down at the track, playing the ponies.  Much more fun and less trouble.  At least until Manny's boys came over and said, "You never lose.  Wanna come 'splain to Manny how that is?"
     I couldn't think of any examples of target-return pricing.  Had to google 'target return pricing examples'.  Turns out the leading example of a corporation that uses target-return pricing is General Motors.  Hahahaha!
     I think we can leave target-return pricing to the eggheads at the University of Chicago School of Law.

Value-based pricing.

     "Price your product based on the value it creates for the customer. This is usually the most profitable form of pricing, if you can achieve it."
     Note the simplicity of this model.  Forget production costs (well, almost).  Forget markup.  Show the customer your product and ask him what he is willing to pay for it.  Voila!  The customer has just set the price.
     If you figure you can make money at the customer's price, you make a sale.  Then another.  And another.  As word gets around, you make as many sales as you have product.

Psychological pricing.

     The customer's perception determines the price.
     There are a number of subdivisions of psychologocial pricing, but the big one is Price Points.  Ever notice how many items are priced $19.99?  ('Cause the ATMs spit out twenty-dollar bills.)  Or restaurants advertise lunch specials for $5?  ('Cause you have a fiver in your pocket.)
    The key is setting the price to make the purchase an impulse buy.  In slang, a no-brainer.  You don't want the customer to think about the product too much.  You want the customer to think "What a bargain!"  The latter leads to a quick sale.

     You know what?  Over time all these methods converge to Value-based pricing. 
     My father said, "You can buy quality once or cheap many times."  How true that is. 
     My father used only standard grade (A grade) lumber.  Other contractors used utility grade (C grade).  As you would expect, my father's costs were higher than other contractors and so his bids for the same house were higher.  My father also used 5/8" steel in his foundations; code required only 1/2".  That was only one instance.  Every one of his construction practices exceeded code. 
     Word got around that my father delivered a quality product.  When times got rough, other contractors couldn't find work, but my father still had a 2 year backlog.  That when he was running three crews and turning out a new custom-built home every month.
     Because the perception of value was there.  The product history justified that perception. 
     I recently bought Terry Pratchett's Hogfather for my Kindle.  Someone asked me how much I paid for it.  I didn't know.  Had to look up the receipt.  I paid $9.59 for it.  But I didn't care.  I knew Hogfather to be a great book.  At the price quoted, I knew I would get value for the money, and I didn't think twice about hitting the one-click button on Amazon.
     The customer will pay for value.
     Keep that in mind.
     The customer will pay for value.
     You in the back. . .write this down.
     The customer will pay for value.

     Next time:  TradPubs Pricing.
* That there are not more pricing methods shows that economists lack imagination.
** Wild Ass Guess.

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