One of the most important and challenging decisions that you can make as a small business owner is how to set your prices. There’s a lot of work that goes into the number a consumer sees on a tag, or that you relay to your client. Still, the art of pricing is not an exact science. It involves weighing multiple factors and consolidating an accurate picture of what your product is worth, how much it costs to produce and what your customers are willing to pay.
Here’s a breakdown of the most important factors to consider when setting prices for your goods or services:
Before you think about attaching a number to your goods or services, you should have a strong understanding of the market in which your business operates. The price of similar products, and how well they’re selling, is valuable information. It can help you determine where your business fits in the market at large. However, it’s also important to consider variations that could impact the price of the product. This could include the location in which the product is sold, or the raw materials used. Both of these are examples of factors that could impact the willingness of customers to purchase your product or service at a certain price. No detail is too small when you’re conducting your initial research.
It’s also necessary to understand the value customers attach to products like yours. Value represents the customers’ willingness to pay. When this willingness to pay is transformed into a numerical value, it often represents the maximum price you could successfully charge. Whether or not your product is considered a commodity can influence the value (or perception) of your offering. If your product or service is considered a daily necessity, something the customer can’t live without, then customers will likely see it as extremely valuable. Alternatively, if your good or service is more of a “nice-to-have”, rather than a “need-to-have”, the associated value may not be as high. The difference between these value perceptions can greatly affect the price at which you should sell your good or service.
Cost of goods
Knowing how much it costs to produce your product or run your service is crucial. This amount can help you determine the mark-up on your product, and thus the profit you can achieve. The goods you need – whether it’s cashmere for your fashion business, or social media algorithms for your marketing business – are a recurring cost. These costs are intrinsic to your business, and without them, your supply chain will likely collapse. Combine the market research you’ve compiled with your production costs to get a realistic idea of how much profit you can make on each unit.
Labour is the other major production cost that can’t be ignored. Particularly for service businesses, labour is a fixed cost that impacts your total overhead and increases your production costs. If you’re a health care practitioner, or plumber, for example, and you require particularly skilled labour, factor this cost into your pricing. It may mean you have to charge more for your product or service to ensure you cover the cost of high quality and specialised skill.
Running a business involves many additional costs. From rent for your storefront or office, to new equipment, or air conditioning, overheads factor into the total cost of production. Therefore, calculate the costs and consider them when setting your prices. Otherwise, they will cut into profits and throw your business plan out of whack.
Another major cost that no business owner can ignore is distribution. Your product or service has to get to the customer some way, right? Shipping, drivers and other means of transportation necessary to get your product to where it needs to go, are all costs associated with running your business. Whether you’re distributing directly to customers, or through wholesalers and intermediaries, consider these costs when determining your price.
Economies of scale
In addition to ascertaining your production costs, it’s good to consider what the future may hold when setting prices. What will change in your costs as your business grows? Will you need to open more warehouses, stores or offices? What costs can you account for in your strategy, even when you’re just starting out? If you foresee extensive growth in the future, you might be able to benefit from economies of scale – your costs can decrease as your capacity to produce increases. Staying ahead of these types of expenses will give you a leg up, even at the beginning when you’re starting from scratch.
There is no perfect way to set prices. However, a smart pricing strategy involves knowing what factors to pay attention to, and what information to gather. Follow these criteria in your research, and you’ll be in good shape to set the best possible price for your products.