Most small business owners and service providers find it challenging to set their prices. What should you charge for your products or services? This is not an easy question to answer. In this post, you're going to learn a variety of methods that will help you not only pick a price, but pick the right one.
Why It's Important to Get the Price Right
If you undercharge for your products or services, then you'll be losing revenue. Alternatively, if you charge too much, you could be losing potential customers and new sales. So how do you get it right?
Having a pricing strategy not only helps you sell your products or services in the short-term, but also increase your profitability over the long-term. The key is to understand the fundamentals of pricing and what value you offer to your target market.
Value vs. Price
We often use the words 'value' and 'price' interchangeably, but they actually mean two very different things.
Value is what a product or service is worth to the customer. Only the end-user can decide whether something is valuable to them or not.
In a previous post you defined your unique selling point (USP), so you already have an idea of how you can add value to your products or services with the extras you provide.
Popular Pricing Strategies
There are several pricing models commonly used to determine price.
(1) Cost-Plus Pricing
With cost-plus pricing, you work out all your costs, then add in a percentage for the amount of profit you want.
'Costs' means everything that goes into producing the product or service. It includes raw materials, labour, and overheads like rent, insurance, heating, employee benefits, and so on.
There are two kinds of costs to consider: fixed and variable costs.
Fixed costs stay the same no matter how much or how little you sell (e.g. office rent or employee salaries).
Variable costs change and most rise as your sales increase. For example, raw materials (you need more of the raw materials to meet rising demand), extra labour (you have to hire additional workers), and shipping.
In pricing your products, you need to take into account that variable costs will change and make allowances for that.
(2) Value-Based Pricing
By being clear on the value of what you are offering, you are helping the customer to see which product or service is best for them.
This helps them to buy what best fits their needs.
What you're aiming for is to find the right fit between what you have to offer and what the customer really wants.
This is why you have to determine the value first and highlight what's unique about your product. Then you can set your price.
(3) Competitor-Based Pricing
In this pricing model, you analyse your competitors and market conditions and set prices accordingly. This method can be effective because you're charging the "going rate" for a product or service. If customers are currently buying something from a competitor for X amount of money, this indicates that this price is something they're willing to pay.
When you decide on the price using this strategy you can choose to:
- Undercut: Make sure that any pricing covers your costs + profit; if not you won't stay in business for long.
- Offer your product or service at a slightly higher price: Remember to emphasise the value.
(4) Service-Based Pricing
When charging for services, like coaching or consulting, you have two options:
- Hourly/daily rate (price for a fixed period of time)
- Project rate (price per project)
Service providers often like hourly rates because you're guaranteed that your labour costs will be covered by the buyer.
Buyers often find it harder to budget for hourly rates and therefore prefer project rates. The price is for the whole project and there are no surprises.
Service providers need to ensure their project contains everything they need and how long it will take.
Choose Your Pricing Strategy
The nature of your business will usually dictate the type of pricing strategy you adopt. For example, a smartphone store won't use hourly based pricing but an app developer might.
Here's a way to get yourself thinking about pricing. Think of something you have bought in the last month or so. From a pricing perspective, ask yourself:
- Why did you buy it?
- Was it good value?
- Are you loyal to the brand?
- What differentiates them in terms of their pricing from others?
- What can you learn from this for your own business?
Now you have some more of the information you need to make decisions about your own pricing policy.
- What are the pros and cons of each of the pricing strategies for my business?
- Which of these models will most help me price my product or service? Why?
- How will this pricing strategy enable me to meet my revenue targets?
- How will I monitor the effectiveness of my pricing strategy?
- What will I price my MVP (mininum viable product) at? Remember, this may be a discounted price in exchange for feedback.
Decide on a pricing strategy for each of your products and services.
This doesn't have to be set in stone. Pricing is an ongoing process. What works today may not work in 6 months' time. You'll need to revisit your pricing regularly, so make sure you continue monitoring and experimenting with adjustments.
You can read the whole Starting a Business series here:
Part 1: Develop a Success Mindset
Part 2: Define Your Driving Vision and Values
Part 3: Pick the Right Business for You
Part 4: Identify Your Niche & Target Customer
Part 5: Choose a Business Model
Part 6: Set Up the Business Essentials
Part 7: Start Branding Your Business
Part 8: Choosing the Right Pricing Strategies
Part 9: Set Up Your Marketing