How to Best Set Prices for Your Small Business

When I had just started working as a freelance blog writer, I had an important question to address. How much was I going to charge for my services? I researched what others were already charging.

But that offered little help.

Some freelance writers were charging too low while others were too expensive. I had three choices here: copy the low guys, take a middle ground, or charge as high as I could. But I had concerns with all these options.

Charging too low would mean getting clients easily. But this would mean working as a slave (not to mention that quality would suffer). Charging too high, on the other hand, would mean a difficult time trying to convince clients that I deserved the big price tag.

Small business owners face the same kind of situation. They know they have a good product. But finding the right price to attach to it is the difficult part.

effect-of-price-on-profitability-mckinsey-study-infographic

You need to take price-setting seriously. It represents the only part of the business that brings money. So if you make a mistake, you put your business goals in jeopardy.

 

Understanding Price

If asked what price means, you would probably say “the amount of money needed to buy something.”

But price represents more than this.

Let’s imagine you want to buy a laptop. Laptop A has 4 GB of ram while laptop B doubles this to 8 GB. For simplicity, let’s assume other features on both laptops are the same.

Also, let’s assume that laptop A is priced at $300 while B is going at $400.

Which laptop are you going to buy?

different-pricing-for-laptop

Will you buy more ram?

Or is the difference in ram not worth the extra $100?

There is no right or wrong answer. It all comes down to how you use a computer.

If you love multitasking and playing video games, 8 GB of ram will certainly make a difference. So laptop B is your way to go.

If, on the other hand, you are a light user who only needs a laptop for music, email, and casual browsing, 8 GB of ram may be an overkill. So in this case, laptop A is your way to go.

The extra $100 is not worth it. In other words, it will not get you any added value that you can’t get from laptop A.

Value is the word you need to understand here.

A popular marketing saying claims that customers do not buy products. They buy value or benefits. This is what price is in the mind of your ideal customer. Even though they may not know, it is what their brains are thinking when faced with a buying choice.

customers-compare-prices-of-different-products-before-buying

Value is what makes you buy an iPhone and not any other phone (assuming you are an Apple fan). Value is the reason you pay for expedited shipping. And that same value is why your customers will choose your products or your competitor’s.

 

Dangers of Wrong Pricing

Make a product. Know its cost. Decide how much profit I want for it, and I have a price.”

Many like to think this way. But this is not the ideal solution to price-setting in most situations. Actually, this is among the reasons most small businesses get pricing wrong: they either under or overcharge. And both these are bad.

Undercharge: the most obvious danger with this is that you lose potential profits. And in some cases, you may even make losses.

But there is more to undercharging—customers will perceive your product as of low quality (liable to breaking, won’t work as good as advertised, may cause injury, etc.).

In this study, buyers claimed better relief from an expensive pill than a cheaper one. But this was nothing more than a placebo effect.

Overcharge: the danger with this is that your price will scare potential customers, which is not a problem if they are not your target.

The good thing with overcharging is that you make your products look luxury. This is best accompanied with a marketing campaign that also tries to portray your brand the same way.

There is no one way to set the right price because it is dependent on several factors:

The competition: Your customers will always try to find the best deals. As such, they will compare your offering to that of your competitors. If you seem to be undercharging or overcharging, that will be a red flag.

Suppliers: every business has suppliers. If these decide to raise their prices, it means reduced profits for you if you don’t do the same.

The economy: this has broad ramifications on price. But one of the most notable things is its effect on supply and demand. If demand is low, which is usually the case in a struggling economy, supply becomes high. In order to sell, businesses cut prices to attract consumers.

supply-and-demand-can-influence-your-price

The nature of your product: is your product one of a kind? And does it not have any direct competitors? Then you can charge more for it.

Your brand: How people perceive your brand can also influence your prices. If people see it as luxury, they will be ready to pay more for it. And if they see it as a budget option, they will expect low prices.

 

3 Basic Pricing Strategies

Value-Based Pricing

This is one of the best pricing strategies you can use. But unfortunately, it is also among the most difficult to understand.

With this strategy, you price your product based on how customers value its features.

First, you have to know the next best alternative to your product. For instance, let’s imagine that you make and sell a weight loss pill. If the next best alternative (your competitor’s product) sells for $50, you can then work your price from this.

pricing-weight-loss-pill

You need to know the Unique Selling Proposition of your pill. Let’s say it is only made from natural ingredients. And that it does not need exercise or special diets to show results (for the purpose of this example, let’s consider this ok—exercise and diet are important). The next best alternative requires a special diet and daily exercises.

Now that you know your pill’s unique values, you need to decide how much customers will be willing to pay for these. You should then give a price to the unique values of your pill. Add this amount to the price of the next best alternative, and you have your price. Read this article for more on how to use Value-Based Pricing.

Here is an excellent MIT study on how most businesses get pricing wrong and how Value-Based Pricing can help.

 

Cost-Plus Pricing

This is probably the simplest of all pricing strategies.

Cost-Plus Pricing adds a percentage of profit to the cost of producing each item (or service). What you get is the price to charge for your product.

You might already have a good idea of how much each product costs you to make. If so, your main objective is to decide how much profit you want.

If the cost per product is $20 and you would like to make a profit of 30%, then your selling price should be $26.

Watch this video for more on Cost-Plus Pricing.

 

Competitor Based Pricing

Your competitors are a great concern that you must keep them in your rear-view mirror at all times regardless of what pricing strategy you choose.

Competitor-Based Pricing is also fairly simple. And it works well for products that are difficult to differentiate.

To use this strategy, make a list of all your competitors and arrange them in order, from the cheapest to the most expensive. Decide where, on this scale, you want to fit.

If you don’t have a lot of competitors, pick any one that’s most similar to you. Take its price, add or subtract a small percentage to arrive at your own price.

However, many are under the assumption that competitors are always right. But this is not always so. If your competitor is undercharging, just copying its price means you will be leaving money on the table. And in some cases, if your costs are higher, you may make losses.

 

Conclusion

That is how you can price your products as a small business. Research has shown that most managers do not give pricing the attention it deserves. And this affects their profits. Since you now know that pricing is important, and you also know the basic pricing strategies, I am sure you will give your products (or services) the prices they deserve.

Victor
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Victor

Victor advises new entrepreneurs on how to start and grow their businesses on this blog. He also works as a freelance writer. In his spare time, he likes to read books and watch movies.
Victor
Follow me
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Victor

Victor advises new entrepreneurs on how to start and grow their businesses on this blog. He also works as a freelance writer. In his spare time, he likes to read books and watch movies.

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