A common concern for all business CEOs is how to price their products or services to achieve their financial goals? A dilemma lurks! Price them too low, and you won’t make enough profit to stay in business. Price them too high, and you’ll have trouble selling anything. Many startup business owners make a common mistake: giving away their products or services for free (or almost free) to get their first clients. This devalues what you’re selling and makes it difficult to raise prices later.
The following are several common strategies for pricing your products or services. I suggest you look at these alternatives and focus on what makes sense to your situation.
Cost-plus pricing is based on the cost to make a product or provide a service, plus a specified profit margin., You add up the direct material costs, direct labor costs and overhead costs involved in production; figure out the per-unit cost, and then mark it up by a specified percentage to arrive at the per-unit price.
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Cost-plus pricing can also be used for services. In this method, you would charge the customer for all the material, labor and overhead costs of providing the service, plus a percentage markup.
How do you determine your markup? Make sure it’s enough to cover all of your costs (not just those involved in making your product) and still provide enough profit margin to cover your fixed overhead costs. Many industries have standard markup ranges you can use; your industry association or your SCORE mentor may be able to give you these.
Cost-plus pricing is simple to use as long as you have accurate measures of all of your costs. However, this method doesn’t take into account what the competition might be charging or what the customer is willing to pay.
Value-based pricing bases the price on the perceived value of what you sell. This often has no relation to the product’s actual value. For example, you can buy white T-shirts in a three-pack for $10 at the drugstore, or you can pay hundreds of dollars for a white T-shirt with a designer label. They both serve the same purpose, are made from the same material and look essentially the same; the difference is in the perceived value of the designer name.
You can get ideas for value-based pricing by conducting surveys of your target market and asking how much they would be willing to pay for your product or service. You can also look at your closest competitors. What do they charge for their products or services? What makes yours better (and more valuable) than theirs?
Value-based pricing can be very profitable. Because it tends to work better for niche businesses, it can be a good strategy for a small business. However, you need to ensure that you deliver on your value promise in order to keep charging these high prices.
Wholesale vs. retail pricing
Will you sell products both wholesale and retail? For example, you might make jewelry that you sell directly to consumers for retail prices at your website, and also sell it wholesale to boutiques around town that resell it to their customers. If this is the case, you need two different pricing strategies — one for wholesale and one for retail — to get sufficient profit margins from both types of sales.
Set your retail price first. Give your wholesale customers a suggested retail price that’s the same as the retail price you’re charging your direct customers; otherwise, they’ll undercut you on price. Then figure out how much you need to charge the wholesalers to cover your cost of making the product and provide a profit margin. Your retail profit margin will be higher than your wholesale profit margin; however, since wholesale customers buy larger quantities, the volume will make up for the lower margins.
Tiered and volume pricing
Tiered and volume pricing charge lower prices to customers the more units they buy. These methods are commonly used in B2B businesses where customers are buying a large volume of products or buying services (such as software) for a large number of people. However, there are some important differences between the two.
Tiered pricing sets different prices for items based on different levels, or tiers, of the amount purchased. For instance, you could have three pricing tiers:
- Tier 1: If you buy 1-100 units you pay $10 per unit.
- Tier 2: If you buy 101-200 units you pay $9 per unit.
- Tier 3: If you buy 201-500 units you pay $8 per unit
Be careful here. What happens if a customer buys 500 units? I suggest that you may price the first 100 at $10 apiece; the next 100 are priced at $9 each, and the last 300 are priced at $8 each.
In volume pricing, you set different price levels similar to tiered pricing. However, once the customer reaches a higher tier, all of the units purchased will get the lower price. In the example above, if the customer bought 500 units, all 500 would be priced at $8 each.
Dean Swanson is a volunteer Certified SCORE Mentor and former SCORE chapter chairman, district director and regional vice president for the North West Region.