Setting prices: business skills

Setting your prices too high can drive your customers away, but charging too little could leave you in the red. Learn more about pricing strategies in small business and find out how to set the right price for your product or service.

Don't price yourself out of the market. Image by fsse8info via Flickr.

Setting the right prices for your product or service is essential to your business's success. To come up with appropriate numbers, you need to look at three factors:

1. Your costs.

2. Potential demand.

3. What your competitors charge.

I'll now look at each of those three factors in turn.

1. Your costs.

There are two basic kinds of costs you need to calculate - your variable costs and your fixed costs.

Variable cost is the price per unit of your product, and it takes into account factors like:

• the cost of manufacture,
• package and shipping,
• import duties,
• credit card fees,
• warehousing costs.

It's always a good idea to make sure your pricing covers your variable costs.

You will also want to take into account fixed costs, like:

• staff salaries,
• rent,
• utilities,
• insurance,
• loan repayments,
• marketing costs.

You can check if your pricing is on track by multiplying your total price per unit by the number of units you estimate you can sell in a year. The figure you get should cover all fixed costs and variable costs and still leave you a reasonable amount of profit. Keep in mind that while your variable costs will often go down the more you sell, you should be conservative in your sales projections. This will lessen the risk that you won't be able to cover your costs.

2. Potential demand.

You need a good idea of how many sales you can expect in order to set the right price for your product or service.  This is called a sales forecast or demand forecast, and there are a number of different methods you can follow to generate one, from making an educated guess, to more complex quantitative techniques which use historical sales data or data from test markets. What method you use will depend a lot on what stage your business is at; if you're just starting up, historical sales data won't be easy to get hold of!

As a starting point, you could make an educated guess and ask other people in your business to do the same to get a consensus. If you have a sales team, you could also ask them what they would realistically expect to sell each month. Another idea might be to do a customer survey to find out about their purchasing habits. You can find out more about sales forecasting on the BusinessLink website.

3. What your competitors charge.

It's essential to know what customers are willing to pay and you can get an idea by looking at competitors' rates. Carrying out market research or holding focus groups can also help you establish a reasonable price.

If your customers are likely to buy your product or service based mainly on price, looking at what your competitors are charging will help you to avoid pricing yourself out of the market.

Charging less than your competitors may look like a good way to gain market share, but there are some potential pitfalls. If your competitors are larger or better established, it is likely their costs per unit are lower than yours. It may be a better idea to develop other selling points. You should also keep in mind how you plan to position your product in the marketplace. There are many situations where you can charge more than the competition. For example:

• if you're selling a luxury product, pricing below the competition might make customers think your product isn't as good;
• you can charge more for a unique product that people can't get elsewhere;
• many customer will pay more for great customer service;
• if you have a brand that people know and trust you can charge a premium.

You might want to consider using price discrimination to maximise your sales - charging different prices to different customers. For example, you may offer a discount to students on a product that is usually too expensive for them, in the hope of reaching a wider market.

You should also think about price fluctuation in the market. For some small business, demand is seasonal. Raising your prices during peaks or offering off-season discounts may be a good pricing strategy if demand for your product changes significantly throughout the year.

Take a look our previous business skills post on PPC for small businesses and don't forget to come back next week to learn about tax and VAT.