Once you start a business, how do you know how much to price your products for? If your product is priced too high, it won’t sell. If it’s priced too low, you’ll be swamped with orders, and have such a small profit margin, it wont even be worth the effort. Finding the balance is the trick.
What Goes Into Cost
Your price should:
- Cover your costs
- Highlight the value you provide your customers
- Earn you a reasonable profit
- Be competitive
There is no such thing as the perfect price. It’s all about developing a price that your customers are willing to pay, that also makes you a profit. Because remember profit is how we keep score in business. Pricing effects every aspect of business because price is used to create sales projections, establish a break-even point, and calculate profit.
There are three ways to price your product correctly:
1. Look at the Competition
Use your competitor’s price as a reference point. If your product is of a higher quality, and you can justify more benefits, then you can probably justify a higher price point. The goal must be to stay competitive. If your product is knock off, then your price point will be less.
2. Calculate the Total Cost of Your Product
This should include your hard costs (labor, materials/inventory, packaging, shipping.) You should also include a percentage of your overhead expenses such as (legal, accounting, marketing, and administrative costs). Once you have a all your costs then you need to determine your profit margin to calculate the final price. Depending on what you sell the profit margin could be anywhere from 30 percent to 300 percent.
3. It’s All About the Perception of Value
Perceived value is one of the most common factors business owners use to determine product pricing. Unfortunately, some small business owners we perceive their value to be much greater than their would-be customers, which is a great way to go out of business. The main factor that adds value to a product is the brand behind it. Lots of stores sell mixers, but if you have a Kitchen Aid mixer, you have a top of the line machine. Why is that? All mixers basically function the same.
It’s all about the perception of value. The Kitchen Aid mixer has a higher perceived value.
Let me give you a quick MBA lesson:
Price = (Labor + Materials) x profit margin
What that profit margin is will depend on your industry and who you’re selling to. If you’re selling wholesale, you might double what your labor and materials cost. If you’re selling retail, it might be double what you’d charge wholesale.
Don’t Compete on Price
There’s often a pull to be the cheapest seller on the block. Resist the urge, otherwise you people will assume your products are lower quality. Someone will always be able to offer similar products cheaper than you, so this is a no-win situation.
Don’t Be Afraid to Charge a Premium!
People pay based on perceived value. If you are confident — and competent — and can point to great work you’ve done in the past, people absolutely will be willing to pay what you charge.
It’s easier to charge more and come down in price than to start out low and then charge more. If your prices seem to be too high for your marketplace, test out different promotions and see what price point resonates with your audience. Psychologically, you may see better results simply offering a discount occasionally than to reduce your prices across the board.
Test Your Price Point
Pay attention to people’s response to your prices. If you don’t want to cut your profit margin down, consider adding more value to what they get, such as a free product, or discount on future purchases.
Republished by permission. Original here.
Ice Cream Shop Photo via Shutterstock
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I would add that when you test your price, it’s easier to start high and then bring the price down than the opposite. People will be happy to learn that prices are lower and unhappy to learn that prices have gone up.
Thank you indeed for your helpful post. Pricing new items some times is a problem. You tips are very helpful for those starting out.
A few years ago I started a web design business and foolishly decided to only take into consideration the first point in your list – to look at the competition – and then chose to undercut them. Ended up getting lots of customers (which was good) but had completely underestimated the amount of time each project would take and my hourly earnings worked out quite low.
Good advice in this article – wish I’d read something similar then!