You might be selling the most spectacular product in the world—but price it wrong, and you could still go broke. Too high, and you’ll scare off potential customers. Too low, and you’ll hurt your profitability.
Setting the right price is a complex task, involving everything from production costs to the budget of your key demographic. According to Pam Newman, president of RPPC, a Kansas City, Mo., small business accounting firm, the key is to not shoot from the hip. “Your pricing strategy should be part of an overall business-planning process,” she says.
To do it right, consider the following steps:
1. Understand your costs. That includes both direct expenses—i.e., what you pay for raw materials—and overhead, such as insurance and rent. With that information, you can then determine whether you’ll be able to cover your costs and generate a profit by charging specific prices.
2. Investigate the competition. If there are comparable products or services on the market, you’ll have to know how they’re priced. You might not charge that amount, but you’ll need to use it as a baseline. Then, determine what kind of value you’ll add and the level of quality you’ll offer. Do you want to reduce the price—and the level of quality— and sell larger quantities? Or, does it make more sense to sell products or services offering special features, at a steeper price? “The real competitive advantage for most small businesses is offering something unique,” says Newman.
One sure-fire way to add value—and charge higher prices—is to provide added services. Newman points to a bridal gown boutique that creates customized versions of standard, mass market designs. “[Those] dresses all have a ‘wow’ factor,” she says. And the business is able to charge a premium for that extra element.
3. Understand who your customer is. That means conducting thorough market research, either by hiring a specialist or doing surveys on your own. In either case, your goal is to get a detailed view of who your customers are and just how much they can spend.
4. Rejigger costs. Say you have to charge $200 an hour for your services, but the going rate is $100. If you can’t justify the extra price to customers, you’ll need to cut your costs so you can charge a lower rate. “It’s time to go back to the drawing board,” says Newman.
5. Frequently review your pricing strategy. “Costs change, and it’s easy for profit margins to go down,” says Newman. For that reason, reconsider your pricing strategy on a regular basis. If necessary, take such steps as renegotiating contract terms with your vendors. Or, if you’ve been giving some services away for free, you might need to start charging for them.
6. Slash your prices at your own peril. In a difficult economy, it’s tempting to cut prices to boost sales. But that means you’ll have a hard time raising them down the road. One solution is to keep general prices the same, but offer an additional value that doesn’t cost much on your end.
By doing so, customers might buy services they wouldn’t be likely to purchase at a higher price. Newman cites a women’s clothing retailer that recently offered a reduction on the price of alterations. “That move slightly reduced their profit margin, but it was still a highly lucrative service,” she says. “[It] encouraged customers to partake of something they might not have otherwise considered.”