Correct pricing can mean the difference between business success and failure.
Setting the price point for your product or service is not simply the process of determining the cost of production then adding a mark-up. It is more a matter of understanding the price the consumer will accept as the value of your product or service and keeping the costs of production to a level that will give you a profit at that price.
Consumers Buy for Value
Cost incorporates all the expenses incurred to bring a product or service to a customer or client. Costs include: parts, labour, production machinery, manufacturing space, administration, and transportation to the consumer. These are the true costs of production and a starting point for determining the price to the customer.
It is ultimately the consumer who decides the value of your product or service to them and thus what they are willing to pay. This will be the price that moves your product off the shelf.
Perception Is Everything
If a product is not moving and the price is reasonable given the cost of production and the price of competitive products, it may be that the seller has not provided enough information to the prospective purchaser to establish value. For example, consider the common incandescent 60-watt light bulb that traditionally sold for about 50 cents each. Newer LED light bulbs, providing the same lumens cost $5 to $6, and yet they sell. Why? Because consumers have been given information that persuades them that the newer product has value. Governments and manufacturers have persuaded environmentally aware consumers that long-life bulbs (LED bulbs are rated to last more than 50,000 hours, which is about 35 years if left on for only four hours per day, depending on the type of bulb) producing the same number of lumens at lower operating cost is a value worth paying for. Consumers are told the environmentally friendly LED bulbs will not only help to save the planet, but also save money through reduced electricity costs.
Price is normally determined by cost plus mark-up or by estimating the perceived value of the product/service. Neither method will move your product/service if your competition is selling the same thing for less. Check prices by visiting your competitor’s physical store or going online.
Shoppers are price sensitive. If your price is higher because of your costs, you must convince the consumer your products are better, your warranty is better, your service is better, or that you supply some other advantage. Setting a low price is not the best course of action for any business either. You may enjoy seeing your sales figures improve for a while, but you risk destroying your brand if consumers unconsciously reassign your product to a lower-priced brand category. If you constantly discount, you will eventually be seen as a discounter. Customers will just wait until you drop the price again. If the selling price does not cover all your costs, your business will ultimately fail.
Changing prices should be handled with care. Regular customers are familiar with your prices and if costs suddenly surge there may be a reduction in sales. If you have to change prices, remove the old price tags and relabel.
Customers look at price but see value.
Shoppers may be looking at prices, but they are seeing value. Offer products/services across a spectrum of values (i.e., extras cost more). The automotive industry provides a classic model of this merchandising approach: a base model with the price rising as features are added. This approach connects the purchaser to your value proposition. Power windows, heated seats and a high-end sound system are available on some models but does the consumer perceive them as having value for them?
Once in a while, you may have a unique or trendy product/service or perhaps you supply products/services associated with special holidays such as Christmas, Chanukah, Valentine’s Day, special events such as weddings, etc. These times may allow you to price on a value-added basis rather than cost-plus-markup because the clientele’s perception of what is needed gives them permission to spend more than they would if they were just making a simple everyday purchase.
Know Your Customer Base
Pricing products and services should not be a mechanical process. Owner-managers should examine their entire product line, determine their customer base and the product/services expected, and identify the special events that appeal to the environment they service. Knowing your customer base allows pricing to be in line with your market and customers’ expectations. This will ensure your business will be able to cover all operating costs and secure a profit sufficient to allow it to remain in business for many years to come.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.