Making Better Pricing Decisions
August 31, 2016
Deciding how to price your products and services is one of the toughest choices you'll face as a business owner or manager. Prices affect long-term viability, short-term profits, market share, customer loyalty, and myriad other tangible and intangible aspects of your business. Unfortunately, the guidebook or financial guru who can provide infallible answers doesn't exist. However, certain tried-and-true principles can help you arrive at reasonable and appropriate pricing for your market and industry. Here are three.
- Cover your costs. As a business owner, you can't afford to operate at a deficit for long. The price you charge for a particular product must at least equal the cost of producing that product. Depending on your industry, production costs might include raw materials, storage, salaries, advertising, delivery, rent, equipment, taxes, and insurance. Some of these will be categorized on the income statement as "cost of goods sold." Others will be overhead. Some, such as rent and utilities, are relatively fixed. Others are variable, such as shipping and stocking fees. Simply adding the amount of profit you want to earn as a percentage (called the cost-plus pricing method) is one way to arrive at an appropriate price. Of course, profit margins or "mark-ups" vary by industry, so a restaurant might set the profit percentage lower than a car dealership.
- Know your market. There's no substitute for strong market research. After all, your customers are scanning the market for a good deal. Provide value at a perceived bargain price and they'll tell their friends. Some businesses hire research firms to develop detailed reports on competitors, markets, and forecasts for a particular region or industry. But you may be able to get a handle on your market by using surveys and other methods of ferreting out customer perceptions about your product and service quality, the effectiveness of your advertising, and the reasonableness of your prices as compared to your competition.
- Monitor regularly. Product pricing is not a one-time event. Instead, you'll want to monitor the impact of price fluctuations on sales revenue over time. Overpricing — charging more than a reasonable buyer can be expected to pay — may limit sales. Underpricing may create the perception of poor quality or lead to unsustainably low profit margins.
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