One of the most important decisions a business makes is how to price its products and/or services. It goes without saying that you need to know how much your products or services cost you to provide and that cost needs to include ALL of your expenses (including your operating costs like utility bills) with a portion of the cost allocated to re-investing back into your business. Info Entrepreneurs has a good section on covering your fixed and variables costs on their “Price your product or service” page. How much profit to include in your pricing has a significant impact on your sales, all other factors being equal. Picking the wrong price can mean either leaving money on the table on the one end or pricing yourself out of the market on the other – unless your product or service is truly unique. In that case, you can charge whatever you like but remember, no product or service stays unique for very long. Eventually, you will have competitors and have to lower your prices (a strategy known as “skimming”, covered below).
So your pricing decision is a balancing act between maximizing sales and optimizing profits. Financeit has a good method to help guide your pricing strategy decision: know who your target market is and how much they are willing to pay and think about your business goals, where your business currently stands, and what you want it to achieve. This method involves a form of value-based pricing. Below are some of the most common pricing strategies with summaries of each.
Cost-Plus Pricing
This is the basic pricing strategy of simply calculating your cost to provide your products or services and adding a markup either using a percentage or a fixed dollar amount. Using this method can tell you how many sales you need to make in order to reach your business goals. Keep in mind, however, that you need to have an accurate calculation of your costs and, by itself, this method doesn’t take into consideration the market value of your products or services.
Competitive Pricing
This refers to basing your prices on what competitors are already charging for similar products or services. You then look for ways to differentiate your products or services and use those differentiating factors to justify charging either more or less for your products or services than your competitors are.
Value-Based Pricing
Similar to competitive pricing, this strategy involves researching the market to determine what your target market would pay for your products or services, or how much they value your products or services.
Price Skimming
Referred to above, this is when you are able to charge a higher price because your product or service is new on the market and you have no competitors. The risk with this model is that once you do have competitors, lowering your prices has the potential to alienate customers who, especially in the age of social media, could feel like they were taken advantage of.
Penetration Pricing
This is the practice of entering a competitive market by undercutting your competition until you’ve established your business and raising your prices later. There is also the risk of alienating customers with this approach or having them perceive your business as a “discount” or “bargain” brand.
These are the most basic of pricing strategies. If you run a retail business and are selling other businesses’ products, you have other considerations and may have to use different pricing strategies that include using the manufacturer’s suggested retail price and keystone pricing. Shopify has a good post on pricing strategies for retailers. For information on how you can save your business insurance, take a look at ALIGNED Insurance.
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