Use a variety of ways to arrive at your price
One big mistake I see small business owners make is using only one method to calculate their prices. But, what if your calculations are wrong? Then, you are stuck with a bad price. Instead, I suggest that businesses use several different methods to calculate their prices.
Method No. 1 -Costing out a price
This first method takes into account your costs, your desired profit, and then totals these into a price.
To find your business’s total costs, you have to account for two types; direct costs and indirect costs. Direct costs are those you incur when delivering your service and typically include labor and materials. For example, if you owned a t-shirt store, your direct costs might include the labor to staff the store, the blank t-shirts you buy from a vendor, the decals you apply to the shirts and all the equipment you use to apply the decals to the shirts.
Indirect costs are all the other costs not accounted for in your direct costs, and include things like rent, insurance, phone and utility bills and office supplies. These indirect costs cover everything you need to keep your business operating every day, whether or not you make any sales.
After you’ve uncovered what all your direct and indirect costs are, add them up. Just for fun, let’s say these total $10,000 annually. Now, let’s say you estimate you can sell 2,000 t-shirts in a year. Dividing your $10,000 in expenses by the 2,000 quantity, you end up with a breakeven of $5.00/t-shirt. This breakeven price is the lowest price you can charge and still cover all your costs.
The next step is to ask yourself what profit you want. Let’s say you’d like to have $20,000 to live on during the year (not a princely sum, but I am just trying to keep this simple). This is your profit. OK, now take that $20,000 and divide it by the 2,000 t-shirts you expect to sell, and you come up with $10/t-shirt. Add this to your $5/t-shirt cost and the price you should charge is $15/t-shirt.
Method No. 2 - Pricing competitively
After you’ve established your cost-based price, you want to compare this price against market prices. These are prices your competitors are already getting, and are a key determinant of your own pricing.
Finding competitive information isn’t all that hard; it just takes a little digging. If I were an owner of a t-shirt store like in the example above, I would visit 5 other t-shirt shops and inquire about their pricing. Then I’d ask myself do they offer the same quality t-shirts as me? If their prices are higher, what else are they offering to justify the price? If their prices are lower, is their product quality (or service) noticeably lower? This kind of competitive surveillance is crucial when determining your prices.
Now, what if you are in a business-to-business market, or selling a service? Here are some common sources of information for competitive prices:
- Your preferred customers who can supply you with price sheets from competitors.
- Trade associations who might monitor pricing among the trade.
- Job candidates interviewing with your company—who come from competitors.
Method No. 3 - Pricing by position
Now, set your calculator aside and ask yourself this question “How do I want to be perceived in my market?” This is an important question because your price positions your service (or product) in your prospects’ minds. What do I mean by this? OK, think Ferrari. Now, think Ford. Totally different price points, totally different perceptions, right?
If you want your service to be positioned as higher-end (think Ferrari), you will choose a price point towards the higher end of the price ranges already found in your market. If, on the other hand, your service will be more workmanlike, sacrificing additional features and the finer touches, you’ll price lower. In my book The Marketing Toolkit for Growing Businesses, I identify at least 13 different price strategies you could choose. But to make this easier, I’ve boiled your choices down to just three:
- Premium Price (most expensive 1/3rd of your market)
- Middle Market Price (mid-level 1/3rd of your market)
- Budget Price (least expensive 1/3rd of your market)
Depending on the tier you choose, you will price your product or service in that 1/3rd of the market. So for example, if you choose Middle Market, your price(s) should fall within the middle third of all prices in your market.
Part 3 - Pricing Mistakes and How to Avoid Them
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About the Author
Jay B. Lipe is the author of The Marketing Toolkit for Growing Businesses, a guide for any small business wanting to get its marketing house in order. He is also the CEO of Emerge Marketing, a firm devoted to helping small business owners improve their marketing. He can be reached atlipe@emergemarketing.com or through Emerge Marketing.
