The importance of pricing cannot be underestimated as incorrect pricing can often result in the failure of a business. New businesses often make the mistake of either charging too little or too much for their product or service. So to help you avoid making one of these mistakes, the following section will outline some of the guiding principles of pricing techniques.
Price is a key part of marketing. Setting prices is called pricing.
Prices for products and services can be set by pricing to the market, pricing to your costs, and rule of thumb pricing. New business people with little experience may set an initial price based on the market, and then as experience grows, re-set prices according to costs. These two aspects of price–what is acceptable to the market, and what costs are–must both be considered. In addition, effective pricing depends on the business goals of your company: do you want to maximize profits or are you aiming for high growth in sales? The choices that a business ultimately makes about its markets and sales make a big difference in pricing.
For example, a business may make an early choice about where to position themselves in the market–the “good value,” low end of the market, or the “quality conscious,” upscale market. In pricing, as in everything else in business, the customer is the reference point.
Pricing to the Market
Compare prices with your competitors for similar products and services. Set the price range that customers will expect. You can use that market price range–what is acceptable to the market–as a guide to set your prices. Businesses or people to whom you sell may also price to the market by telling you what they will pay for your product or service. As you keep records of actual costs, the cost approach to pricing will help you make sure all your costs are covered, which may not be true in a market approach to pricing.
NOTE: Be careful about underpricing in order to compete or make sales. Use competitor’s prices to establish the price range for similar products or services but don’t underprice; if your true costs are higher, your final prices will have to be higher.
Cost Approach to Pricing
Price must cover all costs of goods/services sold, including production costs of supplies, materials, fixed overhead, and time/labor, plus a profit. Costs should include costs of production, labour and non-labour, including overhead or fixed costs as well as supplies and materials.
Use this simple formula in setting a price (per unit):
Total Costs of Production Per Unit + Desired Dollar Profit Per Unit
Businesses can set different profit rates, for example 15% profit on supplies and materials, 20% profit on labor/time, and 25% profit on overhead. These more complicated approaches to pricing usually emerge in response to the special needs of a particular business.
If your research reveals that similar products or services are available on the market at a cost much lower than what you could offer, you may have to either adjust your profit margin, the return you expect, or decide to provide enough specialized service or selection that the market will pay the extra. Alternatively, you may be forced to conclude that you cannot afford to make this item or provide this service and look for something else to do.
NOTE: Remember to cost materials at the level it costs to replace them – NOT at original prices; include salaries as a business expense; include interest in your business cost calculations — interest that could have been accrued had the money used in the company been invested elsewhere (i.e. a bank); make allowances for future refunds, servicing, bad debts, amortization of capital costs of equipment or machinery.
“Rules of Thumb” in Setting Prices
Some types of businesses charge prices according to certain “rules of thumb”: For example: price is always twice labor plus materials, or twice materials plus labor depending on which is higher; price is always materials and labor plus 20% for fixed costs, plus 25% for profits.
Calculating actual costs is the only proven way to make sure your prices cover your costs. Labor/time charges are to be covered partly in the costs of production and partly as a salary in the fixed/operating or overhead costs. In summary, key points to consider in setting prices are:
- marketing strategy and your immediate goals
- competitors’ prices, and the market
- market demand for the product and consumer buying trends
- need to cover costs and provide an adequate profit.