When you first start out in business, or even if you’ve been in business a long time and are about to enter a new market, setting the price you want for your product or service is perhaps one of the most difficult decisions you have to make. Ask people to pay too much for your product or service and they will not buy; ask too little and your profit margin will be negligible or customers/clients will assume your product is poor quality.
The first step is to get really clear about what you want to achieve with your pricing strategy: You want to make money. That’s why you own a business. Making money means generating enough revenue from selling your products so that you can not only cover your costs but also make a profit and perhaps expand your business.
The biggest mistake many businesses make is to believe that price alone drives sales. Your ability to communicate value and sell that value is what drives sales and that means hiring the right salespeople and adopting the right sales strategy. At the same time, be aware of the risks that accompany making poor pricing decisions. There are two main pitfalls you can encounter – under-pricing and overpricing.
Under-pricing. Pricing your products for too low a cost can have a disastrous impact on your bottom line, even though business owners often believe this is what they ought to do when times are a little tough. Accurately pricing your product is critical at any point in the economic cycle but no more so than in a recession. Many businesses mistakenly under-priced their products attempting to convince the consumer that their product is the least expensive alternative hoping to drive up volume, but more often than not it is simply perceived as ‘cheap’. Remember that consumers want to feel that they are getting maximum value for their money, most are unwilling to purchase from a business they believe to have less value. Businesses also need to be very careful that they are fully covering their costs when pricing products. Reducing prices to the point where you are giving away the product will not be in the business’s best interest long term.
Overpricing. On the flip side, overpricing a product can be just as detrimental since the buyer is always going to be looking at your competitors’ pricing. Pricing beyond the customer’s desire to pay can also decrease sales. One pitfall is that business people will be tempted to price too high right out of the gate. They think that they have to cover all the expenses of people who work for them, the rent, their overheads, etc. and this is what price it takes to do all that. Put yourself in the customer’s shoes. What would be a fair price for you?
Don’t ask, can’t tell
Asking people what they’d pay for and how much rarely works. For one thing, people will tell you what they WANT to pay—which is obviously much less than what your product or service is actually WORTH. Second, what people say and what people do are very different things. When it comes to money, people are unable to predict accurately whether they’ll pay or not. It’s much easier to spend hypothetical dollars than real ones. Also, it’s worth remembering that people really don’t know how much things are worth, or what’s a fair price (which is the reason TV shows like “The Price is Right” can actually exist). People tend to be clueless about prices. Contrary to economic theory, we don’t really decide between A and B by consulting our invisible price tags and purchasing the one that yields the higher utility. We make do with guesstimates and a vague recollection of what things are “supposed to cost”.
One would expect this information gap to be a major stumbling block for customers. A woman trying to decide whether to buy a blouse, for example, has several options:
- Buy the blouse,
- Find a less expensive blouse elsewhere on the racks,
- Visit a competing store to compare prices,
- Or delay the purchase in the hopes that the blouse will be discounted.
An informed buying decision requires more than just taking note of a price tag. Customers take into account many factors before they decide some of which are:-
- The prices of other items. Not necessarily the same item.
- The prices in other stores.
- What do they think that prices might be in the future (is there going to be a sale in the near future)?
What’s the optimum price?
So how do you go about pricing your products or services? An “optimum price” will factor in all your costs and maximise your margins while remaining attractive to customers.
The first point to really understand is that people never buy on price alone, they use lots of different factors in their decision-making processes, and knowing these factors can have a significant impact on your ability to maximise your return from each purchase.
This will hardly come as a surprise to fans of The Price Is Right. This game show, a mainstay of American daytime programming since 1972, features contestants in a variety of situations in which they must guess the price of packaged goods, appliances, cars, and other retail products. The inaccuracy of the guesses is legendary, with contestants often choosing prices that are off by more than 50%. It turns out, this is reality TV at its most real. Consumers’ knowledge of the market is so far from perfect that it hardly deserves to be called knowledge at all.
Here’s a five-step process for setting the optimum price for your product or service.
Step 1. Know The Market.
Do your research. You need to find out how much customers will pay, this is far more important than knowing how much your competitors charge. Knowing how much your competitor charges is useful too, but should not really be a determining factor in how you price.
Step 2. Know Your Costs.
A fundamental tenet of pricing is that you need to cover your costs and then factor in a profit. That means you have to know how much your product costs. You also have to understand how much you need to mark up the product and how many you need to sell to turn a profit.
Step 3. Know Your Revenue Target
You should also have a revenue target for how much of a profit you want your business to make. Take that revenue target, factor in your costs for producing, marketing, and selling your product and you can come up with a price per product that you want to charge.
Step 4. Setting Your Price.
Here’s where the rubber meets the road, you have to come up with a number and place it next to your product or service. You need to think about the numbers you use as they can have a big impact on the sales you make.
Step 5. Monitor Your Pricing
Another key component to pricing your product right is to continuously monitor your prices and your underlying profitability on a monthly basis. It’s not enough to look at the overall profitability of your company every month. You have to focus on the profitability (or lack of profitability) of every product you sell.
It’s ok reading about it, but the hard part is actually implementing a pricing strategy. Check out our “Pricing Mastery” course to really move ahead with your pricing strategy. To find out more hit the button below.
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