For many small businesses pricing products and services is more guesswork than good judgement. Many business owners make the mistake of matching or beating their competitors’ prices to win more business rather than working out how much they need to charge to make a fair profit and remain in business.
A straight price cut in response to your competition can be very detrimental to your business profitability and personal wealth. If you don’t know what your break-even point is then wholesale price reductions are very dangerous. This tactic will erode your profits and may set your business on a downward spiral that is extremely hard to recover from. It’s wise to sit down and revise numbers thoroughly, brainstorm a pricing strategy that will cover the nature of your products / services in your business market and will make you a fair profit.
The first stage in developing an effective pricing strategy is to know your expenses. It’s crucial to know everything that costs your business money, this includes rent, staff wages, utilities, software, insurance; include loan interest and all other incurred expenses that keep your business running, and don’t forget to add your salary in the calculations.
When you have identified all the expenses associated to your business operations, you can develop your pricing strategy. It’s critical to understand the current state of the market; do some research, refer to your competition and know what they are charging. Remember, referring to your competitor’s pricing is not the only factor to consider, each business is likely to be different from the next.
Lowering your price just because your next-door competitor lowered theirs is inadvisable. And not a solution to sustain your business long term. This tactic, referred to as “reaction pricing” is usually a lose-lose situation. The likely response from your competitor is a further lowering of their price and it soon becomes a race to the bottom. No-one wins this race. A general rule of thumb, a customer perception that your price is too low can be as damaging as one where your price is too high. The adage, “if it sounds too good to be true it probably is” is very relevant in this context.
The other real danger with trying to be the lowest price vendor is that you must also always be the lowest cost operator to sustain that position. If your only tactic is being the lowest price vendor, then you risk being stranded when a lower cost operator comes along.
It is equally vital not to price yourself out of the current market. Rather than just knowing what your competitor’s prices are it is important to understand what they are marketing as their “unique” selling point. Armed with this knowledge, you can then develop and promote your own point of difference to justify a different pricing level. Price your services accordingly, demonstrate the value of your products and services to your customers, show them they get the best “bang for their buck”, this is often referred to as a premium pricing strategy. For this strategy to work effectively you must be able to demonstrate the extra value to your customers and communicate it effectively to them.
Keep an open mind to negotiation to win business. This requires planning and works effectively when implemented properly. Determine the lowest price you are prepared to negotiate down to (but no lower) and build a negotiating premium above this as your starting point.
A few more pricing strategies you can consider, straight discount-for-volume (for when your customer purchases large quantities), loss leaders – products you have and are prepared to sell at a loss to attract and gain new customers, and two-part pricing – a straight up fee option or a per unit charge. Lastly, peak pricing, where a premium is charged for custom or last minute orders is another effective pricing alternative worth considering.
Conduct thorough research on the most effective product offering and selling points you can come up with based on the pricing strategy that suits you and your business. Should you decide to raise your pricing, you should implement your price changes incrementally.
Whenever considering a price change, be it up or down, you should always seek professional guidance and advice on how you can more effectively market your products, with a unique differentiation whilst providing exceptional customer service.
About David Officen
David is the Founder and Managing Director of proCFO. David combines an accounting and consulting background with commercial experience both as a manager for large commercial businesses and as the owner of private and family businesses.