What you should be charging for your product or service is a question that haunts many an entrepreneur. And while “driving sales” is frequently cited as the number one marketing goal of small business owners, many still set their prices without a long-term strategy for achieving that goal.
Your approach to pricing should align with your overall business objectives. And that means - like every other part of your business plan - your fee structure needs to be reviewed and refreshed regularly. So, if you feel it might be time to rethink what you’re charging, here are some things to consider.
Where is Your Business at Now?
Newer businesses, as well as those facing unexpected or seasonal revenue setbacks, are often more concerned with surviving than they are with cranking out profits. In fact, many startups are primarily focused on maintaining positive cash flow - and that can be a good time to gear pricing toward just covering the costs that will keep you in business.
Even if your company is already established, it never stops being important to understand the costs behind your product or service:
- Fixed Costs – also known as overhead – include those expenses that, regardless of sales, don’t tend to change much month over month. These can include rent or lease payments, utilities, and insurance.
- Variable Costs - also known as cost of goods - include those expenses that are directly attached to the manufacture of your product or provision of your service. These can include raw materials, packaging, or shipping, and contractor or commission fees.
Remember: your business can only make money when your fixed costs remain below the threshold of what you charge for your goods, less the variable costs involved in producing those goods. From there, ramping up profits is mostly about trimming your expenses or increasing your prices.
What is Your Overall Game-Plan?
So just how much are people willing to pay for your product or service?
While many entrepreneurs try to answer this question through trial and error, it’s generally less expensive and more efficient to engage in ongoing market research with your target audience. Once you’ve developed a firm idea of what most customers will pay, there are several directions you can go with this data:
- You can shoot low with your pricing to make as many sales as possible,
- You can shoot high with your pricing to make the most money possible from each sale, or
- You can walk the middle ground and try to find the ultimate balance between revenue and profit
There’s no hard and fast rule about which pricing strategy works best because much will depend on what you’re selling, who you’re selling to, and how you position your business in the market.
Focusing on the number of sales you make is a good way to go if market penetration (jumping in and beating out the competition) or economy of scale is your goal (since it often costs less to sell something in bulk). Charging more and making fewer sales on the other hand, is what businesses selling custom or luxury items and services tend to strive for.
In either case, leveraging your knowledge about customer demand should play a prominent role in your pricing strategy.
Top 3 Pricing Strategies
Now that you’ve given some thought to where your business is at and how you’d like to move forward, let’s take a brief look at three key ways you can rethink your pricing.
Strategy #1 – Cost Plus Pricing
Cost plus pricing involves first determining all the fixed and variable costs that go into providing your product or service, and then adding a percentage of that total as a markup to both set the price and generate a profit.
Strategy #2 – Target Return Pricing
Target return pricing is geared toward achieving a specific ROI target or return on your business investment. If, for example, you (or your investors) have sunk a lump sum of money into your company - and your aim is to recoup that money within a certain period of time - you would price your goods accordingly, based on the volume you’re expecting to sell during that same period.
Strategy #3 – Value Optimized Pricing
Value optimized pricing is predominantly determined by the value (dollar, convenience, or aesthetic-wise) that customers place on your product or service. While this approach usually offers the best potential for profit, your fees must be weighed and monitored carefully against client perceptions of what constitutes fair pricing.
Regardless of which pricing path proves best for your business, remember that you and your venture are two separate entities - and both need to generate an income. Too many entrepreneurs make the mistake of heavily undervaluing their time, or of failing to include any kind of personal salary as part of their pricing calculations.