Pricing is one of the most difficult topics in business. There’s not a single catch-all way to set prices – it’s part art and part science. So, where do you begin?
First, consider your costs. You’re in business to make money, right? Your product or service should be priced above your costs. Yes, that sounds obvious. But many small business owners are pricing too low because they have never calculated their costs. How much does it cost you to create and sell your products – materials costs, delivery charges, employee wages and benefits, packaging costs, advertising dollars, overhead, etc. This sets your breakeven sales price – the price at which you make nothing (and lose nothing) by making a sale. Know this number. It will change. Be aware.
Since our goal is to make money, we need to factor in profit.
Here are several ways you can set prices.
- Cost plus pricing – Add a specific target profit margin on top of your costs. For example, if your widget cost you $23 to produce and you want to have a 25% profit margin, you should price your widget at $28.75 ($23 x 125%). Cost-Plus pricing is commonly used in retail sales.
- Pros: It’s easy to calculate. If you calculate your costs correctly, you will always make a profit on a sale.
- Cons: It’s analysis-intensive because your costs will change. If you aren’t constantly monitoring your costs, your pricing will be incorrect. Also, it completely ignores competition and value. Why price at $28.75 if someone is willing to pay more?
- Competitor based pricing – Basing your pricing on what similar companies are charging for similar products/services. This is the pricing strategy I see most often in small businesses.
- Pros: It’s easy – a little research and you’re set. Also, you’ll feel confident in your prices because you know what is in the market.
- Cons: It usually leaves money on the table because your goal should be to provide a product or service that is BETTER than your competition. If your product/service is better, why would you price it equal?
- Value Based Pricing – Pricing your product/service based on what your customers think it is worth. This is the strategy I recommend most often. Talk to potential customers and find out what they would be willing to pay for your product/service. Even if they aren’t interested in buying, you will get great insight into the perceived value of your offering.
- Pros: It typically results in the highest profit margin of the options mentioned. It’s based more on emotion than data.
- Cons: It takes a lot of research to get it right. It’s extremely common to underprice your product or service. Most small business owners undervalue themselves. It’s also hard to scale your business with value-based pricing. As your customer base grows, they will become increasingly price sensitive.
Take an hour to calculate your costs and think about your pricing strategy. Which strategy is best for you? It depends on your business. Overall, most businesses I analyze are leaving money on the table. They could increase prices, but they haven’t because they are afraid or uninformed.
Many small business owners feel lost when it comes to pricing. They can’t explain how they set their prices. They feel like the prices are too low, but they fear that changing their pricing will cause customers to leave. They don’t realize that rising internal costs have eaten away at profits. I see this again and again. You need to change your prices.
I want you to think about your pricing. What are your prices based on? When was the last time you changed your prices? If it’s been 6 months or more, it’s probably time for an adjustment.
4 Oranges is committed to bringing you weekly tips in the form of To-Do List items that you can complete in an hour or less. These tips were generated from reviewing best practices from the hundreds of businesses I’ve worked with over the past 15 years. I expect you’re already doing some (but not all) of them. Improve your business by making quick fixes that have long-lasting results.
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