Our business startup formula:
- Find a group of people to observe
- Determine the maximum amount of money that they are willing to pay to solve a problem
- Calculate the extent of the impact that you can make from the group that you have selected
- Decide whether you want to proceed with the project or business.
Your job as you develop your business startup, or even as you run your non-profit, is to figure out the maximum amount of money that people are willing to pay to solve their problem. When you determine the maximum price that you can charge, many business-owners will recoil. If you are part of a non-profit, you have likely stopped reading because the concept of maximum revenue feels antithetical to a budgeting model where you try to spend every last dollar on your mission. Even though finding the maximum price doesn’t initially sit well with many people, you must focus on maximum price and maximum revenue. We’ll explore why here.
Maximum Profit Is The Lowest Price
We assume that most customers won’t pay more than they are willing to pay for your product. Another way to say the same thing: We expect that customers will pay as little as possible for your product. Since the customer will pay as little as possible, as a business, you must determine how ‘little’ this is. Most companies start by cutting prices or proposing low prices. Then when customers are happy to pay the low prices, the company accepts the purchases as confirmation that they chose the right price.
Rather than starting with lowering the price, companies must begin by asking for the amount that reflects the actual value of the product. Usually, this is simply taking the cost to create the product and adding an arbitrary margin to the price (e.g. $100 plus 20%.) If the customer is willing to pay the manufacturing cost plus the margin, you have found the maximum amount that a customer is willing to pay for the product. You have also found the amount that the customer considers the product to be cheap enough to purchase. Of course, they would be willing to pay less for it, but this would reduce your profit, and it will undervalue your contribution to the customer.
If you do charge your manufacturing cost plus a margin and the customer isn’t willing to pay that much, you will have to reduce your margin. At some point, you will reduce your margin so far that you will have to decide whether it is still worth it to sell this product.
The True Price
There are some situations where you can hold your customer hostage because of your economic pricing. I do not advocate for this. As a company, you may decide that maximum profit has some strategic variables included. Non-profits often choose that the margin they are charging will be close to zero. The non-profit decides that the maximum profit may be cost plus 20%, but the strategic reduction on all work is 20%. As a business, you may also decide that the benefit and impact that you want to provide to society is worth a discount on your margin. The cut will reduce the price that the customer pays, and you will intentionally decide to charge less than the maximum price. The difference between the maximum profit and the profit that you choose to make quantifies the value that you place on the impact you are making.
As a business or non-profit, you must know what maximum profit you can make. Your maximum profit becomes your benchmark to understand how your customers value your business, and the value of the contribution you may make through reducing prices.