There are a variety of different types of pricing strategies in business. However, there's no one surefire, formula-based approach that suits all types of products, businesses, or markets. Pricing your product usually involves considering certain key factors, including pinpointing your target customer, tracking how much competitors are charging, and understanding the relationship between quality and price.
MEETING BUSINESS GOALS
Get clear about making money
The first step is to get real clear about what you want to achieve with your pricing strategy: You want to make money. That's why you own a business. Making money means generating enough revenue from selling your products so that you can not only cover your costs, but take a profit and perhaps expand your business.
The biggest mistake many businesses make is to believe that price alone drives sales. Your ability to sell is what drives sales and that means hiring the right sales people and adopting the right sales strategy.
At the same time, be aware of the risks that accompany making poor pricing decisions. There are two main pitfalls you can encounter—under pricing and over pricing.
• Under pricing. Pricing your products for too low a cost can have a disastrous impact on your bottom line, even though business owners often believe this is what they ought to do in a down economy. Many businesses mistakenly under price their products attempting to convince the consumer that their product is the least expensive alternative hoping to drive up volume; but more often than not it is simply perceived as "cheap." Remember that consumers want to feel that they are getting their "money's worth" and most are unwilling to purchase from a seller they believe to have less value.
• Over pricing. On the flip side, overpricing a product can be just as detrimental since the buyer is always going to be looking at your competitor's pricing. Pricing beyond the customer's desire to pay can also decrease sales. One pitfall is that business people will be tempted to price too high right out of the gate.
FACTORS TO CONSIDER
Know your customer
Undertaking some sort of market research is essential to getting to know your customer. Market research firms can explore your market and segment your potential customers very granularly—by demographics, by what they buy, by whether they are price sensitive, etc. You might just look at consumers in terms of a few distinct groups—the budget sensitive, the convenience centered, and those for whom status makes a difference. Then figure out which segment you're targeting and price accordingly.
Know your costs
A fundamental tenet of pricing is that you need to cover your costs and then factor in a profit. That means you have to know how much your product costs. You also have to understand how much you need to mark up the product and how many you need to sell to turn a profit. Remember that the cost of a product is more than the literal cost of the item; it also includes overhead costs. Overhead costs may include fixed costs like rent and variable costs like shipping or stocking fees. You must include these costs in your estimate of the real cost of your product.
A good rule of thumb is to make a spreadsheet of all the costs you need to cover every month, which might include the following:
• Your actual product costs, including labor and the costs of marketing and selling those products.
• All of the operating expenses necessary to own and operate the business.
• The costs associated with borrowing money (debt service costs).
• Your salary as the owner and/or manager of the business.
• A return on the capital you and any other owners or shareholders have invested.
• Capital for future expansion and replacement of fixed assets as they age.
List the amount for each on your spreadsheet. The total should give you a good idea of the gross revenues you'll need to generate to ensure you cover all those costs.
Know your revenue target
You should also have a revenue target for how much of a profit you want your business to make. Take that revenue target, factor in your costs for producing, marketing, and selling your product and you can come up with a price per product that you want to charge. Do the calculation to arrive at the price at which you need to sell your product in order to achieve your financial goals.
Know your competition
It's also helpful to look at the competition—after all, your customer most likely will, too. It may even be worthwhile to prepare a head-to-head comparison of the price of your product(s) to your competitor's product(s). The key here is to compare net prices, not just the list (or published) price. This information could come from phone calls, secret shopping, published data, etc.
Deciding to raise or lower prices
One size does not fit all. You can only go so far pricing all your products based on a fixed markup from cost. Your product price should vary depending on a number of factors including:
• What the market is willing to pay.
• How your company and product are perceived in the market.
• What your competitors charge.
• Whether the product is "highly visible" and frequently shopped and compared.
• The estimated volume of product you can sell.
That opens the door to raising and/or lowering prices for your products. In order to make this call one way or the other, you should first understand what's already working. Analyze the profitability of your existing products, so you can do more of what works and stop doing what doesn't work. You want to find out which of your existing products are making money and which are losing money. You may be surprised at how many of your products are losing money—fix those ASAP.
You should also constantly re-evaluate your costs. To sell it right, you have to buy it right. If you're having a hard time selling a product at an acceptable profit, the problem may be that you are not buying the product right. It may be that your cost is too high rather than your price is too low.
When to raise prices—and how
You should always be testing new prices, new offers, and new combinations of benefits and premiums to help you sell more of your product at a better price. Test new offers each month. Raise the price and offer a new and unique bonus or special service for the customer. Measure the increase or decrease in the volume of the product you sell and the total gross profit you generate.
It is a fact of life in business that you'll have to raise prices from time to time as part of managing your business prudently. If you never raise your prices, you won't be in business for long. You have to constantly monitor your price and your cost so that you're both competitive in the market and you make the kind of money you deserve to make. But you don't want to alienate your existing customer base by raising prices too steeply, especially during a recession.
When to lower prices—and how
You may realize that you've missed your target audience by pricing your products too high. You can always choose to discount your products or give customers something for free in order to get them to try your product or generate traffic to your storefront or website. Generally, lowering prices is not a good practice unless you're using this strategically to garner market share and have a price sensitive product or if all of your competitors are lowering their prices.
Monitor your pricing
Another key component to pricing your product right is to continuously monitor your prices and your underlying profitability on a monthly basis. It's not enough to look at overall profitability of your company every month. You have to focus on the profitability (or lack of profitability) of every product you sell. You have to make absolutely sure you know the degree to which every product you sell is contributing to your goal of making money each month.
Related story
India reduces price of petroleum products
