One of the stickiest issues for most small-business owners is setting just the right price for their products and services. It’s not a process to be taken lightly, and it can mean the difference between being in the black or being in the red in your business.
Underpricing goods and services is a universal problem when it comes to that process. It's typically generated by small-business owners' fear that they won’t be able to sell anything if the price is too high. But that won't happen if you do your homework and research properly.
How Not to Price
Many small-business owners, particularly service professionals, set prices based on their desire to make a certain amount of salary per year. And that might work if all the key components of pricing were included, but they rarely are. The following scenario illustrates what typically happens when business owners price to earn a specific, annual income.
Bill is a personal trainer who's just starting out on his own. He decided to set an annual income goal of $78,000 so he backed into his pricing by breaking his salary goal into a weekly rate ($1,500), then into an hourly rate. Because he’s planning to work with clients 40 hours every week, the rate he decided to charge his customers is $37.50 an hour.
When Bill has a training appointment, he drives to his customer’s location, so he typically has 30 minutes of drive time between appointments, and each appointment lasts an hour. To reach his income goals, he’ll have to actually work 12 hours a day, or 60 hours per week. But that’s not sustainable for the long haul nor does it account for the time or expenses required to actually run his business.
Let’s take a look at the reality of Bill’s business plan:
Target Weekly Income
Actual Weekly Income
Target Weekly Hours
Actual Weekly Hours
Actual Weekly Expenses
Target Hourly Rate
Actual Hourly Rate
Looks pretty bleak, doesn’t it? Bill will end up struggling to make ends meet in addition to being completely exhausted from working so many hours.
Pricing mistakes drive a lot of entrepreneurs out of business because they don’t consider everything that needs to be included when setting up the proper price structure.
The Key to Perfect Pricing
It can take a lot of testing and tweaking to get to just the right price point. But you can get started on the right foot by including the following five variables when setting your prices initially:
1. Actual cost. Whether you’re selling products or services, there are back-end costs that must be factored into your price. Be sure to include materials, labor, federal and state tax payments, and company overhead in your Your actual cost.
2. Profit margin. You’ll need to determine what profit margin will work best for you; express it in a percentage, such as 10 percent. Add this amount to your actual cost.
3. Target market. Knowing who your target market is and what price point they'll bear is critically important when setting your prices. For instance, it’s possible to set a price that's much higher than your initial estimates if you’re working with a higher-end market.
4. Competitor pricing. Every business has competitors. Finding one that offers products or services that are similar to yours and determining where they are on the price scale can help you decide what prices you'll set.
5. Your value add. This factor might be the toughest to develop, but it's the one component that can make the most difference in your pricing strategy. You need to determine what it is about doing business with your company that makes the real difference for your clients or customers. If you’re not sure, take a look at your customer testimonials or simply ask your customers why they do business with you. Remember, pricing is often about emotion, so the perception of your value from the customer’s perspective is a big contributing factor in your success or failure.
One other thing you might want to do when setting your prices is to completely put the hourly rate issue out of the picture. So, rather than selling a specific number of hours for a certain dollar amount, look at your services from a value-based perspective and create packages that you sell based on how you'll solve a specific problem for your customer. Then quote that package for a lump-sum fee.
Pricing is both an art and a science. The better you get at it, the more your business will benefit by having a healthy bottom line.
See more in the Move Your Business Forward series.