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Don’t lose out – get your pricing strategy right
This article follows on from the one on price setting, and looks at the some of the ways you can use to set your pricing strategy. There are different methods available, and the one(s) you choose will depend in part upon your specific sector.
One big thing that many new business owners struggle with – especially if you experience self-doubt and low confidence – correctly valuing your time and skills. This blog post from fundinggates.com gives 6 reasons why you may be undercharging, and what you can do to fix it.
In this post, we will look at the most common methods of setting pricing strategies. While there are other types of pricing strategies, these are the most common, and the most suited to small and start-up businesses. If you are interested in other pricing strategies this very detailed post provides an excellent breakdown.
Cost plus pricing
This is probably the simplest and most commonly used method. As long as you’ve made sure that you know all your costs, both direct and indirect, then this method will work.
While it’s a simple concept, here is a brief example:
Cost of materials £20.00
Overheads £ 5.00
Labour costs £ 10.00
Total cost £35.00
Desired profit – 20% £ 7.00
Required sale price £ 42.00
For a more detailed example, this article from accountingexplained.com is good.
Many business owners forget to include the cost of utilities, broadband, and other non-direct costs in their overheads. I’ve included the link to this useful, downloadable checklist/calculator before, but it’s too useful to miss out here.
In some industries, prices are pretty much set in stone. This is usually when the product or service are similar to those that everyone else is supplying. Where industries have dominant players, they generally set the market price, which smaller operators will find difficult not to follow. For example, in the UK, a couple of electronics resellers dominate the market. They are able to set the price of laptops, digital cameras and other goods. As smaller businesses sell the same products, they are obliged to offer similar prices or lose business. For a more detailed explanation of competitive pricing, this article will help.
However, for those in this situation, there are ways that you can charge above the market price, if you can prove your worth. For small businesses, this could be customer service and aftercare, extended warranties, or perhaps training included in the cost. As long as you can demonstrate your added value, and differentiate yourself, then you can charge more. If you’re wondering what you can do to stand out from the crowd, VerticalResponse.com offers some great suggestions here.
As I’ve said before, my husband has a cleaning business. Cleaning is a notoriously competitive market. Because his business focuses on a niche market, and offers additional services, such as a seven day service, and specialist cleaning of showers and toilet areas, he is able to justify a higher price.
There are two types of demand pricing: one that reacts to market peaks and troughs; and one that relates to the profitability of different clients.
Anyone who has booked a holiday during the school holidays will be well aware of the effect that the higher demand has on the cost. Prices rise dramatically as competition for places increases, and tour operators know that people will pay the greater cost for a much-wanted break away. American Express explains how this works this in their small business forum.
An example of the second type is that customers who order in bulk are often given lower prices. One reason is that the costs of producing a greater quantity of product are often minimal. Another is that administration and time involved in fulfilling a large order is pretty much the same as for a small order. This is known as economy of scale.
As you can probably see, demand pricing is harder to calculate, and if you choose this option, you will need to be very aware of your costs to ensure that you maximise your profit. And, for many businesses, neither of these pricing strategies will be suitable.
Odd pricing is something that we will be aware of. It uses psychology to persuade people of the value, and is usually used in retail. A common example is products priced at £X.99 instead of the rounded figure.
This is so effective because, when we look at a price tag, it is the first number that has the most impact. When we see a product priced at £4.99, our brain perceives it as a better deal than £5.00, even though it is only a penny difference. This article from Entrepreneur.com explains the psychology behind this phenomena.
Conversely, businesses who want to project quality will avoid using odd pricing. This is known as prestige pricing. Many high-end stores and designer outlets will use this method. Yet, at sales time, when they want buyers to believe that they are getting a bargain, they may switch to odd pricing.
Penetration pricing is when businesses set their prices low to gain a foothold, or even dominance, in a market. While companies may start with lower prices to attract business, this can be a dangerous tactic. It is much harder to raise prices when your customers are used to paying a low cost, and could lose you both money and business in the long run. Investopedia.com’s post on penetration pricing outlines the advantages and drawbacks of this pricing method.
Using this article alongside my previous post on price setting, you will able to form a pricing strategy that will help you grow a profitable and successful business for the long term.