You may have a wonderful product or service to sell but just because you think it's wonderful doesn't guarantee success. In order to get the customer interested you also have to price it correctly and that requires knowing your customers well and what they're willing to pay, as well as what your competitors are charging in order to remain competitive. You might also want to consider market segmentation, product bundling, and the benefits that your product or service will bring to your customers before putting a final price on your product.
So, what are the most important questions to ask yourself before deciding on the correct price?
Have you covered your production and service delivery costs?
All prices must cover costs. Before setting a price for your product, you have to know the costs of running your business. If the price for your product or service doesn't cover costs, your cash flow will be cumulatively negative, you'll exhaust your financial resources, and your business will ultimately fail.
To determine how much it costs to run your business, include property and/or equipment leases, loan repayments, inventory, utilities, financing costs, and salaries/wages/commissions. Don't forget to add the costs of markdowns, shortages, damaged merchandise, employee discounts, cost of goods sold, and desired profits to your list of operating expenses.
Are your prices in line with your longer term business goals?
to maximise current profits
to maximise current revenue
to maximise the number of units sold/number of customers served
to maximise profit margin
survival in market decline
to maintain status quo in order to avoid price wars?
What is the customer willing to pay?
Pricing should mostly be based on what the customer is willing to pay – and to help determine what this is, you can conduct market surveys and enlist focus groups.
What kind of customer do I want to target?
If you target customers who value your product the most and charge a high price, you'll be making more money per sale but limit the size of your market. Is your product a luxury, affordable to the masses or something else? If you target the mass market with a lower-priced product, you'll be making less per transaction but selling a lot more units. The ideal situation is to cut the market into segments with different price points to appeal to all types of buyers.
How should I react to my competitor's prices?
If your product is better than the competition, find the competitive price difference and price upward. If yours isn't as good, find the competitive price difference and price downward. If your competitors change their prices, so should you.
Should I offer different levels of products or services at different price points?
To capture the most number of customers it's always best to give those customers a choice on the costs/level of service they want or need, with different appropriate costs. It's best to offer a basic, medium and premium price to cover all bases.
Should I adjust my prices?
Different customers have a different willingness to pay, and even the same customer will vary in their willingness to pay based upon the purchasing occasion. Companies may be able to achieve a 1-7% margin improvement by adjusting prices to fit specific consumers. It will be necessary to observe customer buying habits and do consumer research through interviews and focus groups before applying price adjustments.
Is the customer willing to pay more for my product?
If a tin of Heinz baked beans sells for 75p per tin but a generic tin of baked beans sells for 32p it's up to Heinz to make sure that the customer understands why there is a difference in price – and values the quality that Heinz provides. Real differentiation comes in product development, perceived differentiation in marketing and sales. In Heinz's case they add real differentiation through strict quality-control measures, and perceived differentiation by advertising quality to their customers.
Can I base my price on value?
Many businesses base price strictly on the product or service itself, but some companies might be better off tying their price to the intangible benefits they deliver to customers – time saving, convenience etc.
Should I bundle my products for a single price?
Ideally you want your customer to buy more than one product from you. Just look at the success that all major food stores have achieved with their meal deals – not just selling sandwiches at lunchtime but also including a drink and a snack for an all-in price. When the customer is buying three items it's a good deal for both seller and buyer.
Should I offer a discount?
Avoid discounting if you can. It's all very well offering promotions from time to time but the standard price should remain just that – standard. If you find that you regularly have to discount in order to sell your product you are either trying to sell something that no-one wants or your're aiming at the wrong type of customer. Consider how difficult it will be if people get too used to the discounted price and demand this as the norm - your profits will begin to slide if they refuse to pay a higher price.
How does the customer want to buy my product or service?
Is it something I should sell for a one-time fee/cost? On an annual basis? On a monthly basis? I'm afraid there's no answer that fits all situations. What's important is that you create a model that fits with how people want to buy your product or service. Give them options. Sometimes a yearly fee seems too much upfront for individuals but a much smaller monthly cost is more acceptable. Good advertising and marketing also helps.
A well-planned and executed pricing policy can help increase your current revenue and profit – but, your pricing strategy should involve constant refinement because what suits today's economic circumstances may not be relevant in six month's time. Try different scenarios to see which pricing changes can help your business grow – and remember to ask yourself these questions before implementing price changes.
- Pricing Strategy: how to price a product, Bill McFarlane, 2012.
- Pricing for Profit: how to develop a powerful pricing strategy for your business, Peter Hill, 2013.
- The Strategy and Tactics of Pricing, Tom Nagle and John Hogan, 2016.