The goal of business is to make a profit. Many small businesses fail at this because they don’t know how to price their products or services, but pricing is the critical element to achieving a profit, a factor that all firms can control.
If you’re a startup or are revisiting your pricing strategy, here are some suggestions from industry experts and small business owners to help you get the price right.
Understand Service Costs and Their Impact On Pricing
Every service has different costs. Many small service firms fail to analyze their services’ total cost and thus fail to price them profitably. By analyzing the cost of each service, prices can be set to maximize profits and eliminate unprofitable services.
The Iowa Small Business Development Center offers a useful course on How To Price Your Products and Services, which includes tips for analyzing your total costs. Components to understand and analyze are:
- Material costs
- Labor costs, including, but salaries plus benefits
- Overhead costs. Any cost not readily identifiable with a particular product is overhead. Taxes, rent, insurance, marketing and transportation are all overhead. Part of the overhead costs must be allocated to each service performed or product produced and must be adjusted annually.
Tip: To help you calculate your gross margin and understand its impact on pricing, read Understanding Gross Margin and how it Can Make or Break your Start-Up.
What Are Your Competitors Charging?
Pricing isn’t just about making a profit and covering your operating expenses, it’s also about where you want to position yourself in the marketplace, explains Scott Gerber, host of Inc.com’s Ask Gerber. Where do you want your brand to be in the grand scheme of things? Perhaps you want to be the high-end competitor to someone who’s at the low-end of the market, or the reverse. The key, as Gerber suggests, is figuring out what’s going to get you the best penetration in the market as fast as possible, and broadening your client base according to what your competitors are not doing with their pricing models.
Useful Tools: Check out SBA’s SizeUp tool to help you assess how your business stacks up against the competition.
Tip: Do not try to compete with a large store’s prices. They buy in larger volumes and their cost per unit is less. Instead, highlight other factors, like customer service.
Take Advantage of Front-End, Back-End and/or Tiered Pricing
This is a common tactic for structuring your pricing model. Gerber suggests thinking of a car dealership. A sales rep knows he has multiple options for generating revenue from every customer who walks onto the lot. So the rep has the advantage of not only locking the customer down on a price for a car (the front-end pricing), but can also be pretty sure that the customer is going to pay more on top of that price for financing options and other add-ons – whether they anticipated this or not. Consider this the back-end pricing option. Bundled together, they equate what is also known as tiered pricing.
Tip: Think of ways you can tier your small business’ pricing structure to sell people early on the notion of a price, and then add options that ultimately will help you increase your bottom line.
Understand Your Conversions And Metrics
Make sure you know how much you’re actually making on a particular product or service so you can figure out if that’s the right fit for that product. As an example, Gerber explains, if you’re selling only one out of 10 customers on a certain product, maybe that’s a sign that you’re pricing it too high. Consider the merits of dropping it by maybe 10-20 percent; you could increase the conversion rate by three or four times. The money you make on aggregate sales would be more than you’re making now on that one product. The bottom line is never assume things are okay as they are and can’t be done differently and perhaps more profitably.
Price Higher Than You Think You Would
An owner of a local fencing and decking contractor recently surprised me by admitting: “I always unwittingly underprice my services.” This wasn’t sales speak; he was simply recognizing that although he’s the best at what he does and has plenty of business, he doesn’t make enough money on the jobs he quotes.
Not charging enough is a common problem for small businesses simply because they often don’t have the operational efficiencies of larger companies and frequently find that, whatever they sell, their costs are higher than they anticipated. Small businesses do have one advantage, though, and it’s one that justifies charging a higher price – service! Here are two blogs that offer tips for leveraging service as a value proposition and revenue generator:
- How to Avoid Falling into a Price War by Focusing on Value
Tip: Other differentiators can help you justify higher prices or selling above your competition. including:
- Satisfaction in handling customer complaints
- Knowledge of product or service
- Helpful and friendly employees
- A convenient or exclusive location
- Exclusive merchandise
Pricing Below The Competition
If you decide you want to adopt a low-end competitive pricing strategy, remember that your profit margin per sale is going to be less so you’ll need to focus on reducing your costs. The Iowa SBDC recommends several best practices for this approach:
Obtain the best prices possible for the merchandise
- Locate the business in an inexpensive location
- Closely control inventory
- Limit product lines to fast-moving items
- Design advertising to concentrate on “price specials”
- Offer no or limited services
Tip: While some businesses can be successful with this strategy – think online retailers who can take advantage of cost-cutting like drop-shipping – it can be difficult to maintain this approach. Why? Because every cost component must be constantly monitored and adjusted. It also exposes a business to pricing wars. Competitors can match the lower price, leaving both sides out in the cold.