SBEC shares tips on how to effectively set prices as a small business

October 14, 2022   ·   0 Comments

Pricing Strategies

Whether you are producing a product or delivering a service, it is important to have a pricing strategy that is both competitive and profitable. How much your customers are willing to pay for your product or service depends on the quality that you offer, the prices charged by your competitors, the uniqueness of your product, and how passionate your customers are about obtaining your specific offering.

The price you charge can make the difference between a profitable or unprofitable business. When setting prices be sure that the price is high enough to cover all your costs and provide a reasonable profit margin. If your products are priced significantly higher than your competition, and you have not provided a distinct competitive advantage, you will be faced with declining demand. Understanding how your target customers make purchasing decisions will help you to set prices within an appropriate range. Business owners must also evaluate how important price is to the customer. In some cases, price may not be a deciding factor when a customer needs a product or a service.

How to set pricing?

The first step in setting prices is to fully understand all your business costs. The more precise your calculation, the greater your chance for a successful business. Your costs will fall into two distinct categories — fixed costs and variable costs. Fixed costs are those that you must pay regardless of the amount of revenue that you generate. Items such as rent, utilities, insurance, and taxes are examples of fixed costs. Variable costs are those that directly relate to the production and or delivery of your product or service. Things such as raw materials, production labour, packaging, and delivery/shipping fees are some examples of variable costs. The amount of these expenses will fluctuate depending on how much you produce.

Four types of pricing strategies

There are many types of pricing strategies and depending on the industry you operate in, some will work better than others. Certain strategies are most appropriate for a new company or a company entering a new market while others are best suited for companies that are established market leaders. 

Competition-based pricing focuses exclusively on the competition and the current market price for a product or service, disregarding the actual cost of the product. Companies that market their product or service in a highly competitive space may need to use this strategy as the consumer may purchase based on price and not be willing to spend extra on a product or service they perceive as fundamentally identical to others. You may also encourage a buyer to choose to purchase from you by differentiating your offering with a more liberal return policy, extending credit terms, or enhanced customer service.

Cost-plus pricing factors in the cost to manufacture a product or deliver a service. It considers both hard costs and soft costs and then applies a mark-up according to the company’s profit expectation. In this case the market price is used to validate the resulting price. If the price is significantly higher than the competition, a review of the costs needs to be completed and either cost savings need to be found or the mark-up needs to be adjusted.

The most common pricing model is known as value-based pricing. In this scenario, pricing is based on what the customer is willing to pay. To maximize both revenue and profits you need to identify who your customers are and thoroughly understand their wants and needs. This process starts out with conducting a thorough market analysis to create an ideal target customer. Once you identify your target customers, you need to determine the value they place on the features and benefits of your product.  The final step is to run a price sensitivity analysis. This will allow you to determine both the minimum and maximum price the customer is willing to pay. Your final price should fall somewhere within this range.

Penetration pricing can also be an effective strategy when entering a new market or introducing a new product. Here, the price is set artificially low to attract customers. This model is not sustainable in the long-term, but it does allow you to get noticed in the marketplace and it is a way to quickly establish a loyal customer base. Once the business becomes established, you will need to raise prices to increase profitability.

Pricing is one of the four ‘Ps’ of marketing along with people, placement (distribution), and promotion.  Whatever pricing strategy you choose to follow, always ensure that it aligns with the way you want to be perceived by your customers and competitors, and that it is consistent with your promotional messages, the places your product is sold and the type of packaging it is sold in.

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