The magic formula for setting prices

Some time ago, after leaving my lecture at a university, an employee asked me to give him a ride to a metro station. During the trip, he asked about my specialty, and I told him I was a professor of pricing strategy and tactics. Immediately, he said I could help him and shared his story to give me context. He had a small homemade coconut candy business and was working on his business plan. However, he had been struggling for months to define his product price and had received multiple, often contradictory, opinions. His main concern was whether his price should be above, below, or at the same level as the market leader, who sold each candy for $200 in stores and supermarkets. My newly acquainted friend expected that in the 10-minute ride to the metro station, I would tell him exactly what price to set. I’m not sure how disappointed he was, but instead of an answer, what he got was a series of questions he needed to resolve before even attempting to arrive at a number.

Who are your customers?
The first thing I asked was whether he was sure who his customers were. This surprised him, as he assumed his target market was the same as the leader’s: housewives buying these candies in stores and supermarkets for family consumption on different occasions—desserts after meals, treats for school or office, etc. He realized that he had overlooked a multitude of possible customers outside the mass market, such as hotels, restaurants, schools, etc. For example, I told him, in the case of hotels, the customer is very different from the mass market leader. What mass customers value is different from what a hotel seeks in these candies. While a child might prefer a large, crunchy coconut candy, the hotel wants small, soft candies to place as a gift on guests’ pillows each night.

Who is your competition?
At this point, my new acquaintance started questioning whether his reference price should really be that of the mass-market leader’s candies. It was clear that, for hotels, the competition would be very different from what he initially considered. Rather than the coconut candies sold in stores and supermarkets, competitors would be other types of candies and chocolates that hotels buy to gift their guests. So, for instance, although a 30-gram candy sold in a neighborhood store costs $200, a 10-gram coconut candy for a hotel should be priced more like a chocolate of the same size, around $100. By changing the reference price, he could even increase the price per gram by 50%. But until now, I hadn’t given him enough clues about the price levels his candies should have if he focused on the hotel market.

What makes you stand out?
Next, I asked what the strength of his product was: low price, unique taste, unique consistency, or any other relevant attribute. He didn’t know. At that moment, I think he realized it was impossible to define his product’s price without understanding its positioning compared to competitors or substitutes, i.e., chocolates and other candies in the hotel segment. If, for example, he could produce and sell his product at very low cost due to cheaper ingredients, larger economies of scale, etc., it would make sense to compete with a low-price strategy, i.e., a penetration strategy. Conversely, if he believed the differentiation of his candies lay in their unique, unmatched flavor, he could opt for a neutral or premium pricing strategy. But exactly how much above or below the market reference price he should go would need to be determined through market research and demand elasticity analysis: if demand were very inelastic, he could sell his coconut candies at $110 instead of $100 per unit, as both price points would result in nearly the same sales volume.

What options do you offer?
Finally, I wanted him to realize that even with a clear target market, there are many types of hotels regarding price sensitivity. Even within the segment valuing differentiation, some might want to buy 10-gram candies for $100, $80, or $120 per unit, depending on their price sensitivity. In short, it’s not enough to set a single price; multiple price levels aligned with different levels of value offered are needed to serve all hotel subsegments profitably. The challenge became even greater, and I’m sure my passenger wished he hadn’t asked me anything! How could he charge different prices for the same coconut candy, simply to match each hotel’s willingness to pay? It didn’t make sense. I explained that it’s not about charging different prices for the same product, but adding or subtracting value or conditions to create distinct offers for each price level. For instance, different packaging, flavors, payment conditions, delivery times, etc. Most importantly, these different price levels tied to certain product characteristics or conditions should be included in a price menu, which must be respected to avoid the sin of price negotiation, especially with corporate clients like hotels. At that moment, we arrived at the metro station and said goodbye. But I managed to tell him everything I could in 10 minutes.

In summary...
These questions and reflections are just some of those that anyone wanting to set prices for their products or services should ask. Most expect a formula in a spreadsheet to output the magic number: the price. But trying to set a product’s price through a formula is like trying to design a marketing strategy via an Excel macro. There are no magic formulas. The final price of a product or service, rather than being the result of an arithmetic operation, must come from a strategic-level analysis aiming to capture all the value offered, based on a determined positioning.