How to Price Your Products: Meeting Business Goals
Get Clear about Making Money
The first step is to get real clear about what you want to achieve with your pricing
strategy: You want to make money. That's why you own a business. Making money
means generating enough revenue from selling your products so that you can not only
cover your costs, but take a profit and perhaps expand your business.
The biggest mistake many businesses make is to believe that price alone drives sales.
Your ability to sell is what drives sales and that means hiring the right sales people and
adopting the right sales strategy. "The first thing you have to understand is the selling
price is a function of your ability to sell and nothing else," says Lawrence L. Steinmetz,
co-author of How to Sell at Margins Higher Than Your Competitors : Winning Every
Sale at Full Price, Rate, or Fee (Wiley 2005) and a business consultant in Boulder,
Colo. for 40 years. "What's the difference between an $8,000 Rolex and a $40 Seiko
watch? The Seiko is a better time piece. It's far more accurate"¦. The difference is your
ability to sell."
At the same time, be aware of the risks that accompany making poor pricing decisions.
There are two main pitfalls you can encounter - under pricing and over pricing.
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Under pricing. Pricing your products for too low a cost can have a disastrous impact
on your bottom line, even though business owners often believe this is what they
ought to do in a down economy. "Accurately pricing your product is critical at any
point in the economic cycle but no more so than in a recession," says Laura
Willett, a small business consultant and faculty member in the finance
department at Bentley College in Waltham, Mass. "Many businesses mistakenly
under price their products attempting to convince the consumer that their product
is the least expensive alternative hoping to drive up volume; but more often than
not it is simply perceived as 'cheap." Remember that consumers want to feel that
they are getting their "moneys worth" and most are unwilling to purchase from a
seller they believe to have less value, Willett says. Businesses also need to be
very careful that they are fully covering their costs when pricing products.
"Reducing prices to the point where you are giving away the product will not be in
the firm's best interest long term," Willett says.
Over pricing. On the flip side, overpricing a product can be just as detrimental since
the buyer is always going to be looking at your competitors pricing, Willett
says. Pricing beyond the customer's desire to pay can also decrease sales.
Toftoy says one pitfall is that business people will be tempted to price too high
right out of the gate. "They think that they have to cover all the expenses of
people who work for them, the lease, etc. and this is what price it takes to do all
that," he says. "Put yourself in the customer's shoes. What would be a fair price
to you?" He advises taking little surveys of customers with two or three questions
on an index-card-sized form, asking them whether the pricing was fair.
Understand Your Other Business Priorities
There are other reasons to go into business. Understand what you want out of your
business when pricing your products. Aside from maximizing profits, it may be important
for you to maximize market share with your product -- that may help you decrease your
costs or it may result in what economists call "network effects," i.e. the value of your
product increases as more people use it. (A great example of a product having network
effect is Microsoft's Windows operating system. When more people began to use
Windows over rival products, more software developers made applications to run on
that platform.)
You may also want your product to be known for its quality, rather than just being the
cheapest on the market. If so, you may want to price your product higher to reflect the
quality. During a downturn, you may have other business priorities, such as sheer
survival, so you may want to price your products to recoup enough to keep your
company in business.
Dig Deeper: How to Price Business Services
How to Price Your Products: Factors to Consider
"There are many methods available to determine the 'right' price," Willett says. "But
successful firms use a combination of tools and know that the key factor to consider is
always your customer first. The more you know about your customer, the better you'll be
able to provide what they value and the more you'll be able to charge."
Know Your Customer
Undertaking some sort of market research is essential to getting to know your customer,
Willett says. This type of research can range from informal surveys of your existing
customer base that you send out in e-mail along with promotions to the more extensive
and potentially expensive research projects undertaken by third party consulting firms.
Market research firms can explore your market and segment your potential customers
very granularly -- by demographics, by what they buy, by whether they are price
sensitive, etc.. If you don't have a few thousand dollars to spend on market research,
you might just look at consumers in terms of a few distinct groups -- the budget
sensitive, the convenience centered, and those for whom status makes a difference.
Then figure out which segment you're targeting and price accordingly.
Know Your Costs
A fundamental tenet of pricing is that you need to cover your costs and then factor in a
profit. That means you have to know how much your product costs. You also have to
understand how much you need to mark up the product and how many you need to sell
to turn a profit. Remember that the cost of a product is more than the literal cost of the
item; it also includes overhead costs. Overhead costs may include fixed costs like rent
and variable costs like shipping or stocking fees. You must include these costs in your
estimate of the real cost of your product.
"Come up with X first. X is your cost of raw materials, labor, rent, and everything it took
to make the product so that if you sold it you would break even," advises Toftoy. "Y
becomes what you think you need to make on it. That may depend on your business.
Restaurants overall make about 4 percent, which is pretty low. If you want 10 percent
then you factor that into your costs and that is what you charge."
Many businesses either don't factor in all their costs and under price or literally factor in
all their costs and expect to make a profit with one product and therefore overcharge. A
good rule of thumb is to make a spread sheet of all the costs you need to cover every
month, which might include the following:
Your actual product costs, including labor and the costs of marketing and selling
those products.
All of the operating expenses necessary to own and operate the business.
The costs associated with borrowing money (debt service costs).
Your salary as the owner and/or manager of the business.
A return on the capital you and any other owners or shareholders have invested.
Capital for future expansion and replacement of fixed assets as they age.
List the dollar amount for each on your spreadsheet. The total should give you a good
idea of the gross revenues you will need to generate to ensure you cover all those
costs.
Know Your Revenue Target
You should also have a revenue target for how much of a profit you want your business
to make. Take that revenue target, factor in your costs for producing, marketing, and
selling your product and you can come up with a price per product that you want to
charge. If you only have one product, this is a simple process. Estimate the number of
units of that product you expect to sell over the next year. Then divide your revenue
target by the number of units you expect to sell and you have the price at which you
need to sell your product in order to achieve your revenue and profit goals.
If you have a number of different products, you need to allocate your overall revenue
target by each product. Then do the same calculation to arrive at the price at which you
need to sell each product in order to achieve your financial goals.
Know Your Competition
It's also helpful to look at the competition -- after all, your customer most likely will, too.
"Are the products offered comparable to yours? If so, you can use their pricing as an
initial gauge," Willett suggests. "Then, look to see whether there is additional value in
your product; do you, for example offer additional service with your product or is your
good of perceived higher quality? If so, you may be able to support a higher price. Be
cautious about regional differences and always consider your costs."
It may even be worthwhile to prepare a head-to-head comparison of the price of your
product(s) to your competitor's product(s). The key here is to compare net prices, not
just the list (or published) price. This information could come from phone calls, secret
shopping, published data, etc. Make notes during this process about how your company
and products -- and the competition -- are perceived by the market. Be brutally honest in
your evaluation.
Know Where the Market Is Headed
Clearly you can't be a soothsayer, but you can keep track of outside factors that will
impact the demand for your product in the future. These factors can range from
something as simple as long-term weather patterns to laws that may impact future sales
of your products. Also take into account your competitors and their actions. Will a
competitor respond to your introduction of a new product on the market by engaging
your business in a price war?
Dig Deeper: When Customers Grumble about Price Hikes
How to Price Your Products: Deciding to Raise or Lower Prices
One size does not fit all. You can only go so far pricing all your products based on a
fixed markup from cost. Your product price should vary depending on a number of
factors including:
What the market is willing to pay.
How your company and product are perceived in the market.
What your competitors charge.
Whether the product is "highly visible" and frequently shopped and compared.
The estimated volume of product you can sell.
That opens the door to raising and/or lowering prices for your products. In order to make
this call one way or the other, you should first understand what's already working.
Analyze the profitability of your existing products, so you can do more of what works
and stop doing what doesn't work. You want to find out which of your existing products
are making money and which are losing money. You may be surprised at how many of
your products are losing money -- fix those ASAP.
You should also constantly re-evaluate your costs. To sell it right, you have to buy it
right. If you are having a hard time selling a product at an acceptable profit, the problem
may be that you are not buying the product right. It may be that your cost is too high
rather than your price is too low.
When to Raise Prices -- and How
You should always be testing new prices, new offers, and new combinations of benefits
and premiums to help you sell more of your product at a better price. Test new offers
each month. Raise the price and offer a new and unique bonus or special service for the
customer. Measure the increase or decrease in the volume of the product you sell and
the total gross profit dollars you generate.
It is a fact of life in business that you will have to raise prices from time to time as part of
managing your business prudently. If you never raise your prices, you won't be in
business for long. You have to constantly monitor your price and your cost so that you
are both competitive in the market and you make the kind of money you deserve to
make.
"The best way to determine if the product is being priced correctly is to watch sales
volumes immediately after making any change," Willett says. "This can be done by
watching cash collections (if the business is cash or credit card based) or credit sales (if
accounts receivables are used) for the weeks following. If a price increase is too high,
customers will react pretty quickly. Also watching the competition can help - if you've
made a positive change in prices; competitors are likely to follow suit."
But there is a right way and a wrong way to raise prices. You don't want to alienate your
existing customer base by raising prices too steeply, especially during a recession.
"Rather than have a sudden increase, have a strategic plan over two to five years
during which you gradually increase your price 5 to 10 percent," Toftoy advices. "If the
business is in trouble and you say, 'Hey, I'm going to mark everything up"¦ that kind of
scares people away. This way you haven't gone from $5 to $15. You've gone to $7.50
first."
"In terms of raising the price -- this is more easily accepted in 'good' economic times,"
Willett says. "As the underlying cost of producing the product rises, the customer is
prepared to accept the rise in the price to them. If the customer perceives that the firm's
costs are going down while their price is going up. This will not be received well and is
likely to backfire."
When to Lower Prices -- and How
You may realize that you have missed your target audience by pricing your products too
high. You can always choose to discount your products or give customers something for
free in order to get them to try your product or generate traffic to your storefront or
website. "You have to get people in," Toftoy says. "People like getting something for
free or some kind of discount. You can make Wednesday senior citizen day when
seniors get a 20 percent discount. Then maybe you can offer a student discount day.
Then all you're doing is keeping the price the same, but to those people you're giving
them a cut but it's not like you've lowered all prices."
Generally, lowering prices is not a good practice unless you are using this strategically
to garner market share and have a price sensitive product or if all of your competitors
are lowering their prices, Willett says. "An alternative to lowering price is to offer less for
the same price which will effectively reduce your costs without appearing to reduce the
value to the customer," she says. "Restaurants have found this particularly helpful in
terms of portion sizes but this same strategy can be applied to service industries as
well."
Monitor Your Pricing
Another key component to pricing your product right is to continuously monitor your
prices and your underlying profitability on a monthly basis. It's not enough to look at
overall profitability of your company every month. You have to focus on the profitability
(or lack of profitability) of every product you sell. You have to make absolutely sure you
know the degree to which every product you sell is contributing to your goal of making
money each month. Remember: "People respect what you inspect."
Here are some other practices to help you price right:
Listen to your customers. Try to do this on a regular basis by getting feedback from
customers about your pricing. Let them know you care about what they think.
Keep an eye on your competitors. If you don't have deep pockets and can't afford to
hire a market research team, hire some college students to go out on a regular
basis and monitor what your competitors are doing.
Have a budget action plan in place. Try to have a plan for your pricing that extends
out three to six months in the future.
You owe it to yourself and to your business to be relentless in managing your product
pricing. Remember, how you set the price of the products could be the difference
between the success -- or failure -- of your business.
Dig Deeper: Making the Case for Higher Prices
Related Links:
Case Study: Finding the Right Price for a Hot Product
Luke Skurman's quirky college guides were a big hit. The problem was getting readers
to pay. What if he gave the content away?
Recession Pricing Strategies: How Low Can You Really Go?
Tempted to cut prices? You're not alone.
The Price Is Right
Setting prices has always been more art than science. New software aims to change
that.
The Right Price
Too many new entrepreneurs harm their own prospects by under pricing their goods
and services. But if those company owners just take the time to think, they can set their
prices closer to fair market value.
Is It Time to Raise Prices?
Boost your bottom line by taking the guesswork out of pricing.
Flexing Your Pricing Muscles
Despite years of almost no inflation, you may have more pricing power than you think.
Here's how to exercise it without bruising yourself in the process.
Recommended Resources:
The Art of Pricing: How to Find Hidden Profits to Grow Your Business
By Rafi Mohammed
www.rafimo.com
The author has a very interesting point about how to get out of the pricing "Catch 22"
by adopting a multi-price mindset.
How to Sell at Margins Higher than Your Competitors: Winning Every Sale at Full Price
by Lawrence L. Steinmetz, and William T. Brooks
National Federation of Independent Business
This trade association for small and mid-sized businesses maintains a section on how
to set prices, when to give discounts, and when to raise your rates, among other topics.
U.S. Small Business Administration
Government agency for small business matters operates a website devoted to market
and price decisions that businesses must make.
Editor's Note: Looking for Business Loans for your company ? If you would like
information to help you choose the one that's right for you, use the questionnaire
below to have our partner, BuyerZone, provide you with information for free:
What type of business financing are you interested in obtaining at this time?
Business loan
Cash advance against credit card income
Loan for equipment purchase
Equipment lease
Commercial mortgage loan
NEXT ▷
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