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Once you have a product or service, you have to set a price for it.

This may be the most misunderstood exercise in all of marketing.

Worse, the world's leading expert on setting prices--Marty Chenard--doesn't even have a Web site. (He relies on word of mouth more than word of mouse.)

So I guess I have to tell you.

Ready? Here's the secret:

How do you set your price? You ask people.

OK, it's a little more complicated than that. You have to ask the right question in the right way, and you have to know what to do with the answer. (There's even some calculus involved.)

You start with an “S”-shaped curve, the demand curve. (This is the calculus part--it's a plot of sales and market acceptance over time.)

Demand for a good or service starts rising slowly, because you have to explain it. You're mainly dealing with “geeks” or “early adopters” here.

Then, if the product is worthy, you get a sharp ramp upward in sales, as the “average Joe” gets into the market. This is when your profits are going to be highest, along with your stock price.

Finally, demand levels off at a high level, and you start to get a replacement market. Margins erode, you go for market share, and you look for a new product or service so you can start the exercise again.

This curve holds whether your product is a piece of software or a string trimmer. You start slow, you're hot for a while, then you're a replacement product.

It's important to understand where your price should be to maximize profit:

  • When you're starting out, you want to price as high as possible.
  • In the heart of the market, you want to be competitive.
  • When you get to the replacement market, you need to offer a bargain to keep up your market share.

Once you know where your product sits on the demand curve, you're ready to start the exercise.

You write a script. You describe the product or service thoroughly and dispassionately. You don't mention its brand, you don't “sell” it. You just write what it does, its value proposition.

You give this description to about 40-50 strangers. Not friends, not employees, not insiders, strangers. Average people you've never met before.

Then you ask these people, what would be a fair price for this product? What would be a bargain price? What would be a full price, one you might pay but would have to consider? You should also ask these people if they would be interested in the product as you just described it. (Give those names to your sales staff.)

Now you've got some important data. You look for the median in those numbers, all three of them. You look at your demand curve again, and calculate where you fall on it. If this is a new product, you use the high or “push” price. If it's a replacement product, you go with the “bargain” price.

You can see this logic appearing on PC shelves right now. PCs are now a replacement product, at the end of their product life cycle. Some people don't have PCs, but most do, and there's a large replacement market.

So PC makers are going to great lengths to keep prices low. Instead of bundling capabilities in, they're taking stuff out. (Microsoft Office is the big loser here.)

Printer makers are doing the same thing. I recently bought a printer without the required USB cable, something I didn't learn about until after I'd bought it. (Buyers beware, and look at the fine print.)

We're also starting to see the same thing happen in the handheld market, where Palm's new Zire lacks an expansion slot but does come in at under $100 retail.

There's a lesson here, of course, for the general market. We need new ideas, new products, new services. We need to learn what people would like computers to do, we need new computers that do those things, and we need new people to get those products to market.

Oh, one more thing about pricing:

You must repeat this pricing exercise regularly. The public's view of pricing changes over time. But I've basically described the whole secret: Want to set the right price for your product? Ask people what they would pay for it.

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ABOUT THE AUTHOR

Dana Blankenhorn  (danablankenhorn@mindspring.com) is the author of the new book, The Blankenhorn Effect: How to Put Moore's Law to Work for You, available at Amazon.Com.