The traditional marketing mix framework of product, price, place (distribution) and promotion has been in existence for more than 50 years. Virtually all undergraduate business and MBA programs discuss the interplay of these four marketing elements and how they relate to the success of any business. Despite the obvious importance of the second “p”—price —small business owners have a difficult time figuring out how much to charge for what they sell.
Many have absolutely no idea how much to charge.
Why is setting prices so difficult for small businesses?
Setting prices is difficult for any size business. But small businesses tend to have a harder time. This happens for several reasons.
Want to read more about pricing strategy? Check these out:
Small businesses have imperfect information
An important part of pricing correctly is having accurate information on competitors’ pricing and customer perceptions on value. Unless your business sells a commodity, there is a lack of transparency among competitor pricing. I recently met with a business owner preparing a bid to manage a high-end training event for over 1,000 attendees. Since this was the first time he had ever done an event of this scale, he had no idea what to charge nor was he aware of how his competitors priced similar projects. He also lacked a sense of how important the event was to the client—an important gauge of value perception.
Small businesses lack cost stability
Some costs can be predicted with certainty (like employee salaries), but others can’t be. The current political situation in the Middle East and North Africa has led to skyrocketing oil prices. Large companies can afford to hedge against these risks, but many small businesses lack the knowledge and budgets to do so. They attempt to set prices to take into account potential changes to their cost structure without the ability to predict what those changes will be. Chasing a moving target is never easy.
A lack of resources leads to “desperation discounts”
If you work for a company that generates $10 billion in sales and has $800 million in cash on its balance sheet, you can afford to say "no" to potential customers. A large company’s financial resources provide leverage at the time of price negotiation. Small businesses seldom have that luxury. As the end of the month rolls around and there may not be enough cash on hand to make payroll, desperation sets in and this transforms itself into deep discounts that offer little profits and set a dangerous precedent for future pricing.
Framework for setting the right price
When setting a price for your product or service, there are three considerations that should be taken into account.
- Value proposition to the customer
- Competitive pricing
- Production costs
Value-based selling offers the greatest opportunity for profit maximization. In general, small businesses tend to under-represent the value they add to a customer and, as such, under-price. Every effort should be made—including speaking to current and former employees—to ascertain how your offering is positioned in the mind of the buyer. Since no company operates in a vacuum, you must take into account the pricing offered by competitors.
There is a dynamic tension between these three areas of consideration. The most lucrative strategy is to target the value proposition to the customer. If your industry permits it, go for it. That is where you will see the highest margins, assuming the customer values what you have to sell. If they don’t, then you need to ensure that you at least cover your product costs to break even and stay within what competitors charge.
Other pricing considerations
In addition to this framework there are three additional variables to consider when establishing your pricing.
Importance of client brand
Winning over a well-known company or brand as a client can provide tremendous credibility to your business. The intangible value of this tacit seal of approval from an important company has tremendous value. In this type of scenario, it would be reasonable to accept a lower price (if you had to) in order to win the business.
I recently wrote about the economics of product distribution channels. If the channel you are using to sell offers cost savings versus other channels (or requires additional expenses), these should also be taken into consideration.
This refers to a pricing strategy where multiple products and services are offered for one price. The buyer doesn’t necessarily know the cost of each individual element; what’s priced is the bundle. If your company plans to offer bundled pricing for several products, it’s important to make sure that the bundled price of services is discounted enough to compel customers to buy the package, but high enough to make it worth your while selling. Many times companies provide too generous a discount with bundled pricing which does nothing more than erode your margins.