Pricing is one of the most important decisions you can make for your business. The amount you charge for your goods or services will, in large part, determine what your revenues will be.
There is more to pricing than simply deciding how much you want to charge per unit sold. Pricing is part of your marketing strategy; it's a statement about your product's strengths and weaknesses, and a means of inventory control.
No matter what business you're in, there are three factors to consider before deciding what to charge for your products or services: costs, competition, and customers.
Operating a business involves expenses. Your costs may include:
- Raw materials or supplies
- Equipment and property
The price you charge for your product or service must cover your costs if your business is to survive.
There are two types of costs:
- Fixed costs: These overhead costs like rent, utilities, and insurance are generally the same every period, regardless of how much product is made or sold. While these costs are easy to predict, they are often overlooked when prices are being calculated.
- Variable costs: These costs change in proportion to your business activity. If you are producing more, you will need more raw materials. Variable costs (sometimes called unit-level costs) easily break down to cost per unit.
Your breakeven price is the total cost of your product — fixed cost + variable cost — expressed as a cost per unit. If you charge anything less than the breakeven price, you will lose money.
The difference between what you pay per unit and the price you charge is called the margin.
If you think your profits are the most important factor in determining your price, your baseline price should be the total cost + the desired margin.
The price your competition charges for similar products or services can give you an idea of what price to set for your own.
Price benchmarking helps you understand where you are positioned relative to your competition. If you want customers to choose your product, you'll need to come up with a pricing strategy, and decide if you will charge the same price, a lower amount, or a higher amount, in order to maximize your sales potential.
- Same price: Setting your price in the same range as that of your competition does little to help you stand out and attract customers. This price is best when you have an established client base or if you know you will have a large piece of the market.
- Higher price: You only want a higher price than your competition when you know your product differs significantly from what others are offering. Customers often associate a high price with quality.
- Lower price: A lower price will attract customers who want to save money. It is a good strategy to use when you are trying to break into a market. Be careful that you do not set your price too low; you run the risk of having to increase it later on, and it is much harder to convince customers to accept a price increase versus a price reduction. Customers may associate a low price with poor quality.
Savvy customers know the price they expect to see and what they are willing to pay. Different customers have different expectations. The bargain hunter wants the lowest price available; the lifestyle shopper expects to pay a premium. The price you set helps determine the customer you will get.