Setting Prices for Your Small Business

Setting the right prices for your products or services is a key factor affecting a small business' profitability. Not only does pricing significantly impact your business' bottom line as recorded in your business finance software, but it can also play a key role in how customers and the public perceive your company.

Here are some common methods for setting prices:

Cost-plus pricing

Cost-plus pricing involves calculating the total cost of each unit to be sold and adding a markup. There are various ways to do this, with one of the most common methods combining average variable costs with an allocation for covering fixed costs - then tacking on a particular percentage of profit.

Example: A clothing shop sells dresses with a fixed cost of $5, a variable cost of $10 and a desired markup of 40 percent. In this case, the dress would be priced at $21.

Advantages: This is a fairly simple and straightforward way to calculate prices that will allow you to cover all of your costs and guarantee profitability. It can be especially suited to businesses which use business finance software and sell fast-moving commodities.

Disadvantages: One drawback to using this pricing method is that it does not consider demand, which can heavily influence how much people are willing to pay for an item. Another potential shortcoming is that it does not take into account how the competition is pricing within the same market.

Competition-based pricing

When you use competition-based pricing, you look to other businesses operating in your industry to decide how to position your own company. Using this technique requires doing some research and preparing a profile of your competitors and their pricing strategies for similar products or services.

After you have gathered this information, you may decide to price your goods or services the same as competitors - for example, if you are selling a fairly homogenous product. But if you have a product that can be differentiated from others you may want to charge more. Or you may decide to charge less to penetrate a particular market if that is part of your pricing strategy.

Example: A jam producer has decided to introduce a new line and wants to use market penetration pricing at smaller local grocery stores. Research reveals that a small jar of jam typically sells for $5, so the company decides to price its product at $4.50 to sell higher volumes.

Advantages: This method gives you the flexibility to position yourself in the market and differentiate yourself from other companies. It helps ensure you remain competitive.

Disadvantages: You may inadvertently overlook your production costs if you aim to follow competitors' lead, which could potentially hinder your profitability. Also, there is a chance you could set off a price war with competitors.

Customer-based pricing

This pricing method takes into account the idea of how much customers are willing to pay for your product or service. To use this technique, you must first determine how buyers feel about your product, including whether or not they are willing to pay more for what they perceive as higher quality. You may choose to appeal to luxury shoppers, bargain hunters or position yourself somewhere in between.

Example: A pet food company decides to position itself as a top-quality all-natural alternative to mass-market options by pricing its products high. This is done in conjunction with a targeted marketing campaign aimed at a carefully identified demographic of people who spend a lot on their pets.

Advantages: Customer-based pricing is flexible and companies can use business finance software to set prices that align with their brand image. Prices can be tailored to certain market segments to increase the volume of sales

Disadvantages: Focusing too closely on customers' feelings may mean you ignore what your competitors are doing or forget to factor in production costs. Conducting the necessary research into customer opinions and attitudes may involve hiring an outside company, which can be expensive and time-consuming.

In conclusion

These are just a few of the most common strategies that small businesses use to set prices for their products or services. Remember that many companies combine aspects of a number of different methods to ensure they are covering all of their bases.

Additional tips:Continue evolving. Your pricing method is not set in stone and can be adapted to suit the changing market.

Keep detailed records. Use your business finance software to monitor the effectiveness of your pricing strategy and return to these records to reassess performance on a regular basis.

Lowest is not always best. Experts say one of the most common pricing mistakes made by new business owners is to automatically assume that undercutting the competition is the best strategy. However, the formula for attracting new business is more complex than simply offering the lowest price out there.
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