Set prices with beginning, end point in mind

One of the first problems facing an entrepreneur starting up a new business is the question of what price to charge for the company's product or service. This problem is even more complicated when multiple, related products are being sold. This more complex problem is referred to as the joint-product pricing problem.

In the early 1990s, U-Haul, Budget, Ryder and Hertz-Penske competed intensely in the truck rental market. U-Haul appeared to be the most vulnerable because its trucks had higher maintenance costs, but it charged lower rental prices.

However, if you looked at the bottom line, U-Haul had the highest profit margins; its margins were 10 percent when the industry averaged only 3 percent margins. U-Haul management understood that most customers made choices based on the average daily rental rate for the truck. But once the truck had been rented, customers stopped shopping.

U-Haul knew that the truck rental was only the first piece in meeting the needs of the customer. Once the truck had been rented, customers would need boxes, trailers, insurance, storage space and a variety of other accessories to get the job done. U-Haul charged low daily rental rates to lock the customer in and then priced the accessories at attractive margins.

Have you ever wondered why computer printers never seem to use the same ink cartridges? Wouldn't it be a lot more efficient to have interchangeable ink cartridges?

Printer manufacturers know that the real profit lies in the ink sales after the printer has been purchased. They make little profit on the printers but charge high margins on the ink after the customers have been locked in to their printers and have no choice but to buy their cartridges.

A similar phenomenon occurred in the early days of computers. Back in those days, a company called Univac dominated the industry. IBM was mostly a typewriter company, but when they entered the computer market they practically gave computers away to universities. When the first computer science students graduated, the companies who hired them asked what computers to buy. The answer was: "I only know how to program IBM." Univac was history.

But the real story is what followed.

Because of the advantage created by their success with universities and university students, IBM not only sold computers at much higher prices, but they also made substantial amounts of money with the aftermarket service and support.