Price to value ratio and customer surplus. That's what I want to talk about today. What is it? What is the price to value ratio and what is the customer surplus? There's actually a few different definitions. And one of them is that the customer surplus. According to Google. According to Britannica.
Some I just quickly searched is how much is the difference between a price, the customer, our customer pays for an item and the price that he'd be willing or she'd be willing to pay rather than do without it. So basically what's the difference from what they paid and what they will be willing to pay. But that's not really the definition I want to focus on. Although that's an interesting topic of conversation in and of itself.
But a lot of what I really want to focus on is when you're pricing your services. How much value is actually captured by you and how much value is created for the client. And at least in theory, the more value you create on top of the price. The more valuable and therefore the more. Likely why to sell whatever it is you're trying to sell. As the basis for value pricing. For example, a lot of times a lot of people get hung up on how do I do value pricing?
And. Ah, it's not an easy conversation to have, but it really requires understanding what is the true value of hiring you? And according to Ron baker value is the price that someone is willing to pay for something. But that even with that definition of value, it's really about how much extra value are you creating on top of your prices? So let's say you charge 1000 or 2000 or $5,000 per month. How much. Is expected to, is your client expected to gain in terms of an ROI?
Usually financial, but not always. And if not financial, then what? What emotional benefit are they getting from hiring you? But either way, let's talk about just the financial ROI. How much are people getting back? From the products and services that you sell. And sometimes it's a complicated thing because on the one hand you could drop your prices and sell more of a thing. And leave a lot of value on the table for your clients. And that's a good thing.
You want to create as much value for your clients as you can, and take a fair and reasonable. Commensurate a piece of the value for you and capture some of that value. However, dropping your price obviously will have an impact on what you can do in terms of delivery and scaling issues and the actual hard costs. Although. For consultants, they'd be very low. But time is still a factor. But if you price too low, sometimes people don't want to buy it either.
So that becomes a whole different challenges. So if I'm looking for a solution to a. A an expensive kind of problem. I'm not looking for a cheap solution. I'm looking for something durable. I'm looking for something proven. I'm looking for something that's going to work. If I'm going to invest in say a CRM. I don't want to get something that's brand new. I want to get something that is established has been around a long time. That is fairly mature. In this product development, and I want to.
I want to make sure that's going to be solid. So I'm willing to spend more, to get a good solution because then I can invest in it for the longterm. I don't need to. Buy the cheapest thing, because I want the right thing. I want to buy it right now twice. I don't want to have to migrate my CRM later on. For example, I'm just picking something and then maybe the same with selling marketing services.
So if I really need my company to grow this year, let's say we're going through hard times or or we just have ambitious growth goals, I'm not looking to hire the cheapest option out there. And so companies can afford those that can afford to spend more, we'll spend more because, and prices and values. It's always relative to the person buying it.
So if you're the cheapest option that may appeal to someone who doesn't have money and is looking for a solution, the best solution they can get for the limited funds they have. Ideally, you're selling to people who have an expensive need. Basically they need to have a big gap in where they want to go and grow in their value.
And therefore they're willing to spend a good amount of money to get there, to allow you to invest yourself appropriately in terms of your time, energy, effort, and expertise. All this is to say is when you are dealing with pricing, You want to leave as much customer surplus as you can, meaning you want to leave as much value that the customer. Maintains on top of your costs. So let's say your services cost a thousand dollars a month. Ideally, they're growing by $10,000 a month.
In addition to the regular growth because of you, or if not that directly over the period of a couple of years, the things you do will spin off additional revenue or profit. Over the long-term, you're building out systems, hiring people, and you're creating leverage for them in the business through systems and structures and measurement and ways of doing things. So that would be an example of adding surplus and it should far exceed your prices at least.
Significantly exceeded prices to account for variables and risks of things, not working the way they were intended. So the contrary factor here that I want just hone in on for a second. Is that. If. You're not charging enough no one wants cheap advice. I think there was a, there's a book on pricing psychology. That I can't remember. And I think I wrote about it before.
And what it was basically saying was that they had a hard time selling these seats at this Broadway type show in New York for cheap, because no one wanted the cheap seats. They were in the back and they weren't that great. What they did was actually increased the prices and that actually allowed them to sell more because no one wanted. A crappy experience and whatever else. So even though the seeds were okay, maybe they're just further back or what have you.
No one wanted the cheap seats, so they couldn't sell them. So by raising the prices that actually showed people that there is more value here. So price can be an indication, a signal of value. And so you need to be careful. You can't just drop the price down because then you're going to dissuade the very people you want to help because they're going to perceive it as not a good solution for the thing that they want.
So I just wanted to share this idea with you because on the one hand you want, you need to make sure if you're having trouble selling or retaining customers. You need to make sure there's enough value on top of the prices you charge. Number one. Number two is it needs to be correctly positioned price wise that people take it seriously. And they therefore buy it because it's not, it doesn't seem like a flimsy solution. And the last thing I'll say is that you want to price it in a way.
And this is why I don't always believe in maximizing the price because it affects your longterm. Relationships. I get affects who are. How long has the client got to stay with you? If you're charging 10 grand a month.
It's only a matter of time before they hire a full-time senior marketer to replace your income, your salary, so how do you price in a way that leaves enough value on the table so that they stay with you longer and you capture more profit in the long run and add more value, creating more surplus. And at the same time. If you want people to recommend and re and be highly. Excited about recommending you to people.
Sometimes leaving a ton of value on the table and keeping your prices at a certain level. Allows customers to not only feel like they got a good situation out of working with you, but they got a really good situation out of working with. The value is so dramatic that they have to tell their friends and ideally that's where you're going for. So your price has to be high enough to command your profit. And a lot of people are undercharge and that requires just knowing how.
You know how much value you can create, frankly, from your service. And that takes a bit of experience. Low enough to be compelling and to have a lot of customer surplus, but not too low. That people don't take it seriously, especially people that have. The value of the solution the most and have the highest need for what you offer. So that's the challenge. That's why price is a, this. That's why economics exists. There is pricing is a really challenging. Topic.
I'd rather play with the edges based on supply demand results. How are you doing relative to You're in over your past for your clients. And how confident are you to get an outcome? Because price is always a signal at the same time. You have to keep a high customer surplus, not only to make your clients happy, but also, so that it's profitable for them. But also so that they recommend and refer you in the future. So just wanted to share that concept with you. I hope this is helpful.
It's not about maximizing the initial sale. Sometimes it's about leaving enough customer surplus. On the table so that clients. Love working with you and feel like they've got a bargain and therefore recommend and refer you to others. Like it's a no brainer. To work with you and ideally want your offers to be a no brainer. And that doesn't mean cheap. It just has to be clear ROI. And sometimes it's about you too. It's up to you to prove that ROI. I Hope this helps