For many small businesses, pricing products and services is more a matter of guesswork than logic. Mindful of competitor pricing, they make the mistake of simply undercutting to win business, rather than carefully working out the price that they need to charge – a price that not only covers the cost of doing business but also makes all the hard work worthwhile by returning a reasonable profit.
Straight price cutting in response to competition is a dangerous strategy, one that can ultimately cut your profits to the point where you might as well sell up. It is far better to sit down and work out a pricing strategy that reflects the nature of your products and market AND makes you money!
The first step in developing a pricing strategy is to work out your overhead. It’s really important to identify absolutely everything that costs you money, including rent, wages, utilities, software, and insurance. Don’t forget to include your own salary in this. Also, include the cost of servicing capital assets (loan interest and depreciation charges), including any IT equipment and vehicles that you own.
Once you have identified the costs associated with operating your business, you can begin to think about how you want to price your product. To get a feel for the market, it is a great idea to find out what your competitors charge. However, it is inadvisable to base your prices on this alone because the competition may be offering a different mix of product and associated services. Their overheads are also likely to be somewhat different.
Reaction pricing - lowering your price because the person up the road just lowered theirs - is not usually a workable long-term solution. A price war means no one makes money. In addition, if you position yourself as the lowest cost option, you run the risk of customers leaving you when another, even lower priced alternative comes along.
Conversely, it is important not to price yourself out of the market. So instead of just checking what price your competitors are selling at, evaluate the services they offer their customers and whether they market on the basis of any unique core differentiators. Then consider what you can offer. If you feel that what you can do is worth more than what your competitors offer, price your services accordingly. This is called a premium pricing strategy. For it to work, you need to be able to demonstrate your value to your customers in a convincing way and to get the message out among them.
Be prepared to negotiate your prices to win business. Negotiation involves a little planning but is a useful business tool when used properly. To ensure you are still making money, you need to build a premium into the initial price quoted as well as determine a price floor, which you are not prepared to go under.
Another pricing strategy that’s worth considering is straight discount-for-volume. Loss leaders are also an option, as are two-part pricing strategies. Peak pricing (when you charge a premium for made to order products or for work done at the last minute) is another pricing alternative you can look at.
Take your time to do some homework on your product offering and selling points when determining your pricing strategy, because once pricing is in place, it is difficult to change without upsetting customers. If you are planning on raising prices, it’s a good idea to do it incrementally rather than wait for years and then slug clients with a massive price hike.
The best way to start considering pricing is to first step back and get some professional advice on how you can differentiate your product, improve your marketing, and deliver great customer service. Then you will be able to consider a premium pricing strategy that cashes-in on the things that make you different, rather than fighting it out on cost alone.
Article Provide by: Steven G. Rothschild CPA, CFP®