How you price your product or service can have a big impact. Ask people to pay too much for your product or service and they will stop buying. Ask too little and your profit margin slides or customers assume your product is poor quality. The right price takes account of all your costs and maximises your margins while remaining attractive to customers. Here's how to set your prices
1. Know the market.
You need to find out what your customers are looking for, as well as what your competitors offer and how much they charge. That gives you a framework for understanding the range of different prices and products on offer, and where you fit in.
Simply trying to match – or beat – competitors' prices may not be the best option. If you are selling a bargain product to cost-conscious customers, you might need to set your prices towards the bottom of the range. But if what you offer is high quality, that risks missing out on potential profit.
The price you set can also send a 'signal'’ to customers. A low price suggests low quality. On the other hand, if you sell handmade products, higher prices can help convince customers that they are buying something special.
2. Deciding your pricing objectives.
Ask yourself what you want your pricing to achieve, and choose a pricing strategy that will help you achieve these objectives.
For example, if you are launching a new product you could choose to set a relatively low price to help you build market share. Or it might make sense to take the opposite approach, setting a high price that early adopters will be prepared to pay to get hold of a new and exclusive product.
If you sell a range of products (or services), how do you want these to fit together? Consistency of pricing across the range makes it more likely that customers for one product will buy others as well. Or you might set higher prices for products that are part of your premium range.
3. Work out your costs.
As a minimum, you want to be sure that the price you set covers all your costs – both direct and indirect.
Direct costs tend to be variable: they increase the more you make or sell. For example:
- raw materials and energy used in the production process
- other manufacturing costs
Indirect costs tend to be fixed. These can include:
- money spent developing a new product or service
- employment costs
- general overheads like premises rent and business rates
If you only sell one product or service, it will need to cover all of these costs. If you sell multiple products, each of them can make a contribution towards your fixed costs.
4. Consider cost-plus pricing.
Work out what percentage of your fixed overheads the product needs to cover. Add all of these costs together and divide by volume to produce a unit break-even figure.
You will need to add a margin or mark-up to your break-even point. This is usually expressed as a percentage of break-even. Industry norms, experience or market knowledge will help you decide the level of mark-up. If the price looks too high, trim your costs and reduce the price accordingly.
Be aware of the limitations of cost-plus pricing. It works on the assumption that you will sell all units. If you don't, your profit is lower.
5. Set a value-based price.
Cost-plus pricing looks at how much you need to charge to make a decent profit. Value-based pricing takes a different approach, looking at how much your customers are prepared to pay. The price is determined by how much value your customers attach to your product.
You can get some idea of value by comparing your product to the competition. For example:
- How do the features compare? Does one product offer more than another?
- Are there differences in levels of service, guarantees and so on?
- Are there differences in quality between the products and service being provided?
- What intangible factors should you take into account? For example, brand recognition and reputation.
Ask existing customers what they value in your product, which competitors they rate most highly and why they choose to buy from you.
6. Think about other factors.
How will charging VAT have an impact on price? Can you keep margins modest on some products in order to achieve higher margin sales on others? You might need to calculate different prices for different territories, markets or sales you make online. Do you need to allow for possible late payment by customers? Consider your payment terms and keep an eye on your cash flow.
7. Stay on your toes.
Prices can seldom be fixed for long. Your costs, customers and competitors can change, so you will have to shift your prices to keep up with the market. Keep an eye on what's going on and talk to your customers regularly to make sure your prices remain optimal.
Get to know your customers
Understanding your customers enables you to develop marketing strategies that address your customers' problems, needs or desires. This, in turn, helps you target customers more accurately and fine-tune your pricing decisions.
But how, as a small business, can you collate, analyse and act on your customer data?
Customer relationship management systems (CRMs) record customers' preferences, spending patterns and demographics, allowing you to build a detailed picture of their tastes, needs and buying habits.
Looking for CRM software? Take a look below at some CRM software options for small businesses*.