How the Heck do I Determine the Price I Charge for my Product or Service!?
Updated: Oct 27, 2020
Oh, If I had a loonie for every time I've been asked that question...
Pricing your product or service correctly is key to the success of your business (that may be a colossal understatement).
Unfortunately, many business owners find pricing the toughest, or most stressful responsibility they have. It's part art and part science. And there is no foolproof approach that is guaranteed to work 100% of the time for all types of products, services, businesses or industries.
Pricing involves considerable uncertainty. You have to have a sense of current market forces like supply and demand and overall economic conditions, an understanding of your buyers prime motivators, the relationship between quality, value and price and of course, competitor pricing.
All of these factors are moving targets, that rarely remain constant for more than a short while. So setting your pricing is bound to make even the most confident business owner tremble. At least a little.
With this in mind, let's wade into the deep waters of pricing strategy and see if we can swim rather than sink.
Remember, You are in the Business of Making Money
Before we talk specifics, let's remind ourselves that our primary objective as a business owner is to make money and generate a profit. Our business must be viable and sustainable.
Translation: We must be profitable.
So our pricing strategy, is first and foremost to drive revenue that creates a viable level of profit.
As a business management consultant, I always suggest double digit profit levels. 9% or less is risky business. One warranty issue, under-priced project or lawsuit may be enough to sink your business.
Over Pricing - setting your pricing beyond what your customer perceives the value of your product or service to be is always a recipe for declining sales. No matter what your costs are, and no matter how bad you want to cover your costs and make a profit, you need to keep in mind what is 'fair' to the consumer. If you price you item too high, you ruin your goodwill in the market place and encourage customers to look elsewhere.
Under Pricing - pricing your product or service too low can hurt just as much as over pricing. If you price too low, the consumer will perceive your item as cheap and will begin to question the quality and think that they may not be getting their money's worth no matter how cheap the price is. And of course, setting your price at a break even point puts the long term viability of your business in question.
But, you know all this.
And you're thinking, "C'mon smart guy, tell me something that will help me."
Here are a few key points to consider that should help you.
#1 Know Your Costs
Many business owners do not fully know or understand what it costs to provide their service or produce their product.
Before you can determine pricing, you have to know your costs. You have to know your Direct Costs. That is the costs directly associated with the item like the cost of raw materials or supplies and the labour required to make the product. Then you have to determine the Indirect Costs (overhead) like rent, insurance and utilities.
Once you have your costs nailed down, you can go about calculating a profit percentage to those costs to arrive at your set pricing.
#2 Understand Your Customer
This can vary a bunch from industry to industry, but you need to get to know your customer. Especially your ideal customer.
You need to know what drives their buying habits. If they are value-driven, you may want to focus on a lower price and higher volumes. If they are quality driven, you may decide to focus on that and the higher price tag most consumers associate with better quality.
In either case, your marketing and sales strategy must mirror your pricing strategy.
#3 Know Your Competition
Not many of us are fortunate enough to operate in a monopoly. We all have competition and that competition partly sets the price that we can charge.
I seldom suggest being in the bottom 20% in your market. When you get to this level, the margins get tight, and it is rarely sustainable.
More often, I suggest, being in the top 30% of your market and really focus on the quality of your product or service, your level of service, your warranty and other factors that allow you to charge more than 70% of your competitors.
Again, your pricing and sales, marketing and production strategy must align.
#4 Know Your Market
How is the market trending? Is it a buyers market or a sellers market?
When supply, out weighs demand, that is a buyers market and prices usually soften. When demand is high, but supply is low, prices can normally be raised.
#5 Monitor Pricing & Job Costing
Some companies make the mistake of only evaluating their pricing in January or at the start of their fiscal year. This is a mistake.
Pricing needs to be evaluated individually at the end of every job, contract or project to determine your cost and profit levels on a case by case basis. Job costing really allows you to put your finger on the pulse of your business and your market and make in stream adjustments to your pricing.
To compliment your job costing calculations, monthly pricing needs to be evaluated through your monthly financial statements like your Income / Profit & Loss Statement.
As I mentioned, pricing is not a formula that will work one way all the time. It's anything but that for most industries, markets and business owners.
When I owned my contracting company, I would price a project two or three different ways considering:
1) Does the price provide for my desired level of profit?
2) Does the price take into account any risk or difficulty? (a high risk job meant a higher price)
3) Does the price leave me vulnerable to competitors?
4) does the price reflect the value that I am providing to my customer?
If the answers to these questions was to my satisfaction then the last question that I would ask was,
"Does the price make sense?"
By that I mean, does the price make practical sense? Does it make good business sense?
If the answer was yes, I would proceed with that price. And I would feel confident about it.