The Price is Right
Pricing What is the Right Price for My Product?
This is one of the most common questions business owners must answer. Defining your pricing strategy is critical to your success because it tells prospective customers a lot about your business, helping them place you in relationship to other companies in the market. So how do you come up with that price?
There are many different approaches to pricing. Some are easier to implement and manage than others, and some are more appropriate for specific types of businesses. Let’s take a look at some of those alternatives to help you select the right pricing strategy for your business.
Cost Plus Pricing Strategy
The is the simplest approach and very common in construction and contracting industries. Essentially you start with what it cost you to build or to provide a service. Then you simply add your profit margin on top of that number. The “cost plus” your profit margin. If something costs $100 to build and you want to make $25, you sell it for $125.
While the cost plus approach will guarantee a profit, it doesn’t mean you’re pricing your product or service appropriately. Maybe your cost plus analysis results in a price of $125, but people are willing to pay $200 or $300 because of the value. In this case you are leaving money on the table. Or a competitor comes along with a less expensive process and their cost-plus is only $110.
Value Based Pricing Strategy
With a value-based approach you price based on the customer’s perception of value. When someone buys your product, what’s it worth to them? If you’re selling a business tool or a resource consider how much that customer will save or earn as a result of your product. In order to understand how much value a customer puts on your product you will need to do some research.
With this pricing strategy you start with your competitors. What are they charging for the same product or service? Once you know where the rest of the market is, you have to decide if you want to be a market leader, or follower. Leaders set the pricing at the top of the market. To successfully select this option, you should have the best product available. If your product is average for the the market, playing it safe will put you firmly in the middle of the pack. Or you can choose to be the low cost service provider. This is, however, a difficult position to maintain and you could end up in a price war, with your profits spiraling down as you try to defend that position long-term.
Capacity Based Pricing Strategy
One of my favorite approaches is capacity based pricing. In this pricing model you set your price based on how many units you can deliver. If you’re selling your time that is a limited resource. If you are consistently booked 30 – 35 hours a week, you should probably raise your price. Conversely, if you have lots of free time, inventory in your warehouse, or capacity on your manufacturing machines you may need to drop your pricing slightly.
Another strategy is the quantity discount. With this model you are trying to influence buyer behavior, encouraging people to come back and buy more of your product or service. You might offer a discount for a full year contract or a discount if multiple units are purchased at the same time. This is a win-win approach. The advantage to the customer is they save money and the advantage to you is you’ve got lower selling costs because you don’t have to find a new customer for each one of those units.
This is a variation on the Quantity Discount. Instead of selling multiple units of one product, construct a product bundle which includes two or three related products. Bundled together the price is less than buying each of those units individually. As with the quantity discount, the customer saves money and you don’t need to find as many customers.
When should you raise your price?
There is no simple answer to this question. It is something you should study on a regular basis. Most small business owners under value their product or service, so occasionally evaluating and raising your price, is a good idea. One approach is to look at your last 10 sales. If your price was 5% or 10% higher how many sales would you lose?
Let’s say you sell 10 units for $100 each. That is $1,000 in revenue. If you raise your price 10% and lose one customer your revenue is $990. Have you really lost anything? When you consider you are saving the cost of producing that final unit you will probably roll more profit to your bottom line. This is a simplified example, but do the math for your business and see if you like the results.
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