The wrong price can get your business off on the wrong foot. So how do you ensure you get it right?
Pricing can be a sticky issue, particularly for start-up businesses. The right price starts with the right strategy, a flexible approach that will help define your pricing day by day and ensure you keep selling at a profit and growing your business.
Whether you want to offer top end luxury or cheap and cheerful bargains, you probably know the kind of range you need to price into. But even then, the devil is in the detail and knowing how you compare to the rest of the marketplace takes research and consideration.
No price exists in isolation. It’s important to know precisely what your competitors’ prices are, new and old. Ideally you should know how those prices have changed over time, and what customer perceptions are of the choice on offer.
A lot of purchasing decisions, even between businesses, will be as emotional as they are rational. If customers have historically felt ripped off, that creates a very specific context for your pricing decisions. Of course, you need to compare qualitative as well as quantitative factors. If a competitor is a lot more expensive but offers features and benefits through the roof, you need to take that into account.
A small investment can pay big dividends in terms of getting your pricing right. That investment could be a paid research firm or just an afternoon of your time on the internet. Keep in mind:
When you know the market and your place in it, you can begin to develop a pricing strategy for your business.
It’s worth remembering that most customers can smell if a price is fair or not. They are price-comparing every single day and will probably know the figures better than you, and discuss them readily with friends.
Here are some general pricing strategies to consider when setting your own prices, and analysing your competitors:
This is really an essential starting point to avoid selling at a loss. Calculate all the costs in producing your product or service, then add a margin for your profit. It's a good idea if you get your accountant to check you haven't missed anything, including that your price includes enough profit to grow your business.
For example, if you’re selling outdoor furniture, you need to add up all the costs of manufacturing the furniture – raw materials, labour costs etc. – then add your profit margin on top.
What cost-plus pricing doesn't do is take into account demand, what the competition is charging or market expectations.
Let’s say your business manufactures costume jewellery, and the cost to you to make a necklace (including raw materials and the time you spend actually making it) is £25. You also need to factor in an amount for overheads. The best way to do this is to add up all you overheads, and divide that by your estimate of how many sales you expect to make. So you’d look at adding a margin of 100%, and selling the necklace for £50. Can you sell them for that much?
This is what you’d probably work on if your business is service-based, such as gardening and lawn mowing. What you need to do here is work out how much you’re going to charge your customers per hour. For example, a lawn-mowing business would need to take into account wear and tear on the mower, gas costs for both the mower and travelling to the customer’s property, and the cost of their own labour.
So if you work on a base of £5 for mower gas and wear and tear, plus another £5 to travel to the customer. You might be charging your labour at £25 per hour. You then need to add overheads, so if yours are £50,000 and you can work 2,000 hours a year, you'd add in £25/hour for overheads. Then you need to add profit. If you've decided you want a salary of £100,000, then at 2,000 hours that's £50.
So now the charge out rate is £50 profit + £25 overheads + £25 labour and petrol. If £100 is way over the market rate, then you can look at lowering your overheads and variable costs. Or you could work longer hours, and reduce your profit margin.
Combining margin retail and hourly rate pricing is something you’d do if your business offers both a product and a service. So if you’re manufacturing entertainment units that are custom-built for a client’s home, including installation, you would need to charge your customer for both the unit and the time it’ll take you to install it.
Sometimes it becomes necessary to adapt your prices as you go. This is not a bad thing as long as you do it the right way and for the right reasons.
Reviewing your prices is good practice, you want to check what the industry is doing and possibly renegotiate with suppliers. Benchmarking your prices to competitors is a good way of looking at the effectiveness of your business as a whole. If your margins are low even with a similar or higher price than your competitors, your costs are too high.
Discounting is another common short-term price change, and though it’s extremely common, many business advisers will warn against it. This is because most discounting is done aggressively by well established businesses that can take the hit, or pass the hit on to an already squeezed supplier. Price wars can hurt, but they are a good way get rid of old stock and bump up sales.
Don’t be afraid to raise prices either. Your target market might not be as price sensitive as you think while good customers will appreciate your service and understand. Explain up front and make it clear that it’s their choice to keep buying from you.
A typical scenario is for inflation to creep into a small business’s margins quietly over time and erode profits. So, at the very least, make sure you raise prices with inflation.
Changing your prices may make you uncomfortable, but it’s far better than trading at the wrong price. A good product or service deserves to be rewarded so don’t feel embarrassed about aiming high. It is business after all, and the customer will tell you when you’re getting it wrong. So remember to be flexible, the strategy is more important than any individual price.
This guide is intended as general advice only, and not intended to cover specific circumstances and needs. The information in this article is also not linked to any of the products offered by Clydesdale Bank.