How to succeed with pricing

12th May, 2015

Getting your pricing right in business can be tricky, and it’s all too easy to get it wrong. More often than not, business owners underprice and leave money on the table. This is because business owners typically worry more about prices than the customer does. The customer is normally more concerned about other factors like reliability, honesty, getting the job done right first time, punctuality, speed of service or response, and willingness to put things right if they go wrong.

How do you set your prices? Here are a few of the common methods:

  • Cost plus: There are many variations here, but basically you work out your annual overheads and add the required net profit to calculate the necessary turnover, having adjusted for any mark-up on purchases, and materials or parts. Then break down the turnover into chargeable hours, products sold or cups of coffee made. This a useful method, but it can give you the wrong answer, as demonstrated by a costing exercise carried for a new café by a local accountant. After spending many hours working it all out, she came to the conclusion that a coffee should cost $8, nearly twice the going rate!
  • Market level pricing: Mystery shop the competition; find out what their prices are; and copy them. It’s all very well in theory, but there are so many other factors to consider. For example: do they have a really good USP (unique selling point); a loyal, well-off, long-established customer base; or a great reputation, none of which you enjoy? Or do they have low costs or low aspirations, meaning they give it away?
  • Entry level: Used by new business owners, here you set your prices below the competition to establish yourself and build market share. It’s great for getting going but harder to increase prices (and profitability!) later when your customers expect it cheap forever!
  • Formula methods: Formula methods of pricing are common in retail or wholesale. For example, you multiply the cost of a product by 2.5 before GST or add a percentage like 75 percent to cost, often without any deviation. In fact, these are actual methods used by two clients of mine. When I asked the clients why they used these methods they said, “That’s the way we’ve always done it” or “That’s what the previous owner of the business said to do”.  That’s crazy; there are so many other factors to take into account when pricing.

So what factors should you take into account when setting your prices?

  • Your level of costs: Are you a franchised café, or a café operating from a shipping container or van on the side of the road? No prizes for guessing where your wake-me-up caffeine shot is going to cost more!
  • Your value proposition: What value are you providing to your customers over and above the basic product or service? Do you offer home delivery or worry-free guarantees? Do you make it easy to do business, or do you put up unintentional barriers? 
  • Your expertise and experience: If you’ve built an excellent reputation in your field over many years, then you can justify higher prices. On the other hand, if you’re new, you might have to demonstrate your competence by capturing business using price. 
  • Your competition: How strong is the competition? How much do they charge? Is their level of service in line with their pricing? Do they disguise their true prices by adding extra for travelling or disbursements?
  • Your efficiency: If you’re efficient and have high productivity with experienced, competent staff, you can churn out the work at lower prices. If you’re inefficient with lazy or untrained staff, there’s inevitably going to be higher production costs.
  • Your customer base: Do you have wealthy or poor customers? Are they young or old? Have you built up trust and rapport with your customers? Do you take on all-comers or only well-established businesses who don’t mind paying?
  • Your place in the business life cycle: Are you a new business or established? If the latter, you’re likely to have price-resistant loyal customers, whereas a new business needs to win market share. 

The best way to price is to use a combination of methods and consider as many factors as possible. Get a good accountant experienced in business to do a costing exercise, but in addition, analyse your competitors and consider all other factors before setting your prices.