Pricing - Four Tips of the Trade

There are many, many rules of thumb when it comes to pricing your business's products or services; from what the market or consumers can bear to the level of scarcity (meaning the lower the volume the higher the price - think about what happens to gas prices when oil production is cut).

In fact, there are probably as many pricing rules as there are potential price points.

Regardless of what rule of thumb you may eventually subscribe to, here are four key issues to keep in mind:

Competition: Always watch your competition and how they price their products. Many consumers comparison shop today - especially for everyday necessities. Plus, given the reach and breadth of the Internet (not just computers but smart phones and PDAs), consumers have more information at their finger tips no matter where they are at - to include standing right in front of your product or even while talking directly with you.

Your prices should be inline with your competitors - not higher and not lower. If your prices are higher, you will drive away customers. If they are lower (majorly lower), many consumers will believe (based solely on price) that your products are not only cheap but must also be inferior.

Cost Coverage: Your pricing should not only cover your variable and operating costs but should provide a reasonable profit as well. If you cannot price your product to at least earn the minimum net profit margin of your industry, then you might need to think about changing your business model, changing your business or finding a new career field. The bottom line, you are in business to make money and if you cannot profit, you are only wasting valuable time and resources.

What to watch for:

First, your pricing should cover your variable costs. Variable costs are costs that would disappear completely should your business not produce another item or provide another service. Variable costs can include direct labor, direct materials or any costs associated with directly providing your business's offerings. Most of the time, variable cost coverage can be measured by gross margins. Let's say it cost $5 in materials and labor to product each or your products and you sell it for $10. That means your gross margin is 50% ($10 / $5 = 50%).

Again, back to your competitors. Your industry is made up of you and your competitors. Your industry also tracks averages - averages like the average gross margin for your industry. If your individual gross margin does not at least meet the minimum of your industry, your business needs to make costs changes or pricing changes (if it can) immediately.

Second, your pricing should cover your fixed costs or overhead. After your business covers it direct or variable costs (usually termed cost of goods sold), your pricing should also cover any and all general and administrative expenses (costs that are not directly tied to each marginal or individual product but to the overall business itself). Overhead costs can include (to name a few) marketing, salaries, office supplies, rent, utilities, etc. Any cost that your business would occur whether it produced one product or one million products.

Lastly, profit. You are in business to make money and if your prices, in conjunction with your cost structure, are not high enough to generate a reasonable return (something better than your achieve elsewhere) you either need to make changes in your costs, pricing or both or find other avenues to deploy the resources you currently have that will return some type of profit - be it business profit or investment return. Anything less is just a simple waste of both time and precious resources (money is a resource). Bottom line here is that you are in business to make money and if you cannot do so, you should not be in business - find something else to do with your time and money.

Keep this in mind. If your competitors and thus your industry can make it and survive given their average margins (gross margin, operating profit margin and net income margin) then so can you. If you are forced to set prices in line with your competitors but you are not making similar profits - then you have to find a way to work your costs structure down or your competitors will 'eat your lunch!'

Perceived Value: There are times that you can and should attempt to charge higher prices than that of your competitors. But, you should only do so if you can convince your targeted customers that your products offer a better value - a value that better meets their needs. Example, there are 10 competitors that all make the same software accounting package. But, you want to charge a higher price for yours - Why? Is your product better? Maybe. Maybe not. But you can get away with the higher price if you can convince your market that a feature of your product will make their life easier than your competitor's products. It really comes down to actually convincing your customers - regardless of what YOU believe.

Just know that when charging a higher price than your competitors it will take more than just setting the price. Here, you will also have to bring in your marketing efforts to educate the consumer on the extra perceived value your products or services may offer. Moreover, additional marketing adds expenses; expenses that can offset any price increase so tread lightly.

And finally,

Play Around: Play may seem like the wrong word here but the concept fits. It is very hard to predict what well happen tomorrow. Thus, you have to remain flexible in your pricing. After completing your research, try a price point. Then, converse with your customers. If you are hearing that your prices are too high, change them. If you are hearing that consumers are hesitant, maybe your prices are too low. Just know that nothing is ever set in stone and as the world changes your pricing structure should also change with it.

Food for thought: It is always easier to start high a come down than it is to start low and raise prices.

Pricing is always a struggle for new businesses. Using a low price point to enter a market and gaining share may seem like a no brainer but, in fact, it may harm the long-term viability of your operations. Set price based on your competitors and your cost structure then find new ways - either through product enhancement or cost reductions - to gain that upper hand in your industry.

No matter what rules of thumb you may employ in setting your prices, keep the four topics in mind as your business moves forward. The bottom line is that your business must provide products your customer base wants at price points they perceive as reasonable as well as provide you, the business owners some level of adequate return for your time and risks.

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