There are a couple of different approaches to pricing. Most people have heard, "Charge whatever the market will bear." This is a value approach. Essentially, you are saying, "Let's figure out what the value is to the customer for this item or service and charge that."

It sounds good in theory, but how do you figure out what the value is? In some cases, you can do a pretty good estimate of it. I sell consulting services, and when I do a proposal, I always calculate the dollar impact in increased sales and/or reduced cost of the proposal. In many cases I can show that the proposal will pay for itself in six months or less. In fact, I could use that six-month payback rule as a way of setting the price.

But I don't, which brings us to the other way of figuring out a price: Determine how much it cost you to make a product, add some standard markup to it and use that as the price. This approach is used by many companies that make things that are difficult to value easily such as professional services or some industrial products.

The obvious problem for many companies is how to figure their costs. You might be surprised by how many companies do not know what it costs them to deliver their product. Worse, many companies that think they know what it costs them are badly mistaken, which leads them to make bad decisions.

There are basically four categories of cost for any company: People's time; short life stuff, like raw materials or supplies; long life stuff, like buildings and machinery; and capital. Companies need to estimate the volume and kinds of things they will do in the future and, based on that, how much they will be spending in each of these categories.

There are several hard-to-answer questions that need to be answered to estimate cost: What is your volume going to be, what kinds of things are customers going to want, how variable is that demand going to be (is it evenly spread out or does it all happen on Wednesday evening), and the life of long-life items. I am not going to go any more deeply into how to figure costs. That is the subject of another article, but clearly, this is not that easy.

Yet, even in this "cost plus" approach, the value concept keeps appearing. And there are many interesting implications of this approach.

One is that if you are selling a product or service where it is hard for the customer to figure out the quality of the product, customers often use the price as a guide. This means that they will assume that the higher priced product is better.

We have been studying the market for salmon in the United States. There is a growing base of premium grocery stores and specialty markets that focus on selling high-quality products. One of these markets recently told us that they never price fresh salmon fillets at less than $4 per pound. They have found that if they price them at less than $4 per pound, sales go down. Their customers assume that you can't buy good fish at less than $4 per pound and so they assume that any fish priced less than $4 per pound is not good fish. There are many such examples in marketing.

This means that you can affect the perceived value of your product by how you set its price. Which brings us to the next important point: Pricing should be part of your marketing plan. It needs to support and reinforce the market message you are trying to tell and you need to be sure that you are not damaging your market with your pricing.

If your marketing approach is a value approach, you need to be careful about reducing your price for sales and promotions. You can damage the high-value image. You can also teach your customers to wait for sales. The U.S. auto makers have done this. It is now very hard to sell a car without rebates.

On the other hand, you should be careful not to charge too much for your product. Customers will resent companies making what they think is too much profit. There are interesting cases where companies had a monopoly on a product that customers wanted and charged high prices for it. Customers paid because it was the only choice they had, but as soon as an alternative became available, customers quickly switched to it.

This brings up the topic of price discrimination. This a technique where you attempt to maximize revenue by charging different prices to different market segments, depending on how they value the product. This has long been a strategy of department stores. They knew that some people would pay premiums for the latest fashions, while others would wait to get it at a reasonable price and still others only buy on sale.

The key to making this kind of approach work is that the price differences have to seem reasonable to the customers -- they must still believe they are getting value. Companies can use this technique badly. A good example of this is airlines pricing. Business travelers are viewed as less price sensitive and thus willing to pay higher prices.

Airlines separate business travelers from leisure travelers with the Saturday night stay rule. Note that the Saturday night stay has no impact on airline costs. It is only a way of separating business from leisure travelers. Seats are cheaper because they assume that only leisure travelers will be willing to stay over a Saturday night.

Business travelers are willing to pay more, but there are limits. Airlines can have seats on the same flight that sold for anywhere from $200 to $2,000. This is too big a difference. And here is where we have the danger of price discrimination schemes.

No one today knows what a good value is for an airline seat and customers have changed behavior in response to the prices. For instance, more business travelers stay over a Saturday night.

Pricing is an integral part of your market strategy and should support it, not undermine it. Price is often used to assess the quality of a product, particularly those products that are hard for customers to measure. Be sure not to set your price such that it looks like you are greedy. Customers should perceive their products as being fairly priced based on value to them and profits to you.

Don't create too complicated a pricing structure. Remember that customers will change their buying behavior based on your prices, so be careful with price discrimination approaches, and if you do use them, design your prices to shift customer behavior in directions that you prefer.

David Arnsdorf is president of the Alaska Manufacturers' Association in Anchorage. He can be reached via e-mail at arnsdorf@alaskamfg.com.