The Price is right, isn’t it?

Working out the best price to charge for your products or services can be one of the biggest challenges you face as a business owner, particularly when you’re starting out. Price too low, and you’ll be out of business before you know it; price too high and you’re out of the market. Hit the pricing sweet spot, and you’ll maximise your profits.

Unfortunately, there’s no magic formula. But there are some basic principles that you can apply.

 

Don’t sell yourself short.

Small businesses often undersell themselves, especially service businesses with low overheads. The logic goes that if you can afford to charge less, you should.

Stephen Craft, who runs a specialist financial copywriting business, learnt this the hard way. Despite writing about finance for a living, he made the same pricing mistake as many other small businesses:

When I first ran my own business, I set my rates by looking at similar small businesses. I had lower overheads, so I figured that I could undercut them and still come out ahead. Later I went to work in-house for one of my largest clients. Then I discovered what they were really willing to pay for what I did — a lot more than I’d been charging. It turned out that my competitors were not who I thought they were [other small businesses]. My client had been comparing me to big companies with high overheads and heavy workloads. For my client, the big attraction of my business was speed and responsiveness, not price.

 

Apples v oranges.

The key point here is to know what you’re really selling. Is it your product/service or is it something else, like convenience, speed or reliability? You’ve probably come across the term ‘unique selling proposition’ (USP), which just means what it is that sets you and your business apart. Is your USP quality, service, price or convenience (or something else altogether)?

The bottom line is that price is not always the most important factor for a customer. Really understanding what you offer, and what’s vital to your customer, is key to getting your pricing right. Providing value might mean improving your service, rather than charging lower prices.

You also need to know how sensitive your market is generally to changes in price — can you increase prices without losing business? Or can you drive extra sales with a small reduction in prices? Are you in a niche market where your customers are not particularly price-sensitive?

 

The numbers game.

Once you’ve got a handle on your customer and your market, it’s time to look at the numbers.

You need to know your costs. Your pricing may ultimately be determined by other factors, but your costs are a crucial benchmark. Your variable costs are the cost price of a product (or an hour’s wages, for a service business). Your fixed costs include things like rent, wages, insurance, interest payments and all the other bills you have to pay. Don’t forget to include the real costs of labour, such as leave, super, etc. And never discount your own time!

Your break-even point is when revenues (the income from your sales) exactly cover your expenses. Everything over that is profit.

 

Discounting: yay or nay?  

In most cases, you can’t just up your prices on a whim. Likewise, you should think hard before discounting. There may be times when discounting is appropriate — you may be happy to charge a lower hourly rate for a client who is going to pay a retainer or bring a lot of business, or you may discount to clear end-of-season stock. But be clear-headed — if you have to cut prices to win a customer, is this a customer you want?

If you’re discounting to drive sales, you need to know how much your sales have to increase after a price cut for you to break even. Here’s a handy table.

Price discounts: % increase in sales to break even after a price cut

 

A final word.

In the end, your pricing decisions have to be your own. Don’t be tempted to follow a competitor’s pricing strategy — no matter how similar they may appear, your business is unique, with its own cost structures and customer base, so it deserves its own strategy.