The easiest way to boost your profit margins is something most business owners are scared of: increasing your prices.
Most small businesses haven’t changed their prices since they opened. They set their prices based on the cost of the product or service, the competitors price, and a modest profit margin. Now, like many, they’re fearful that they’ll lose some customers if they increase their prices.
We’ll they’re right. You’ll absolutely lose some of your sales volume with a new pricing strategy. However, as long as the increase in price makes up the initial difference, you’re on your way to a bigger bottom line.
In this article I’ll cover:
- How to boost your margins by adjusting your pricing strategy
- How your prices affect your business beyond the bottom line
- How to develop a pricing strategy for your business
- Types of pricing strategies
- How to test and measure your pricing strategy
The price tag you put on your offering affects your bottom line through more than just your profit margin.
Your pricing strategy is not only important to your revenue stream, but also to the image you project to your customer base about your business and the quality of your products. It can make or break you when you’re trying to tap into new markets, or when you move to a new location. Your pricing strategy is so important to your business that it can clearly make or break your success.
Given its importance, deciding how much to charge for your product or service is a challenging task. You need to factor in your own costs, the product or service’s perceived value, and the going rate. Ultimately, you want to be able to charge as much as possible for each item, without overpricing yourself out business.
Pricing strategies are often overlooked in favour of other marketing strategies, but their impact can be far reaching.
- Profit margins. The price you establish for each product or service has to have a large enough profit margin built into it. This includes fixed and variable costs, as we have discussed in earlier E-Classes.
- Business objectives. What are you trying to achieve with your product or service? Of course your objective is to make money, but how you price your goods can contribute to strategic business moves. Are you moving into a new market? Trying to out-price a competitor? Increase your market share? Your pricing strategy can enable you to do these things.
- Product or service (and business) positioning. You can say a lot about the quality of a product or service with its price. You can also say a lot about your business with your pricing strategy. If you your pricing is low, customers may believe that the offering is of low quality and that you have a budget store. Or, if your pricing is high, a customer is likely to think that the offering is of high or luxury quality, and that you have a high end business.
Work through this process to evaluate and update your pricing strategy so you can optimise your revenue stream and profit margins.
1. Gain a good understanding of your current price structure and profit margins, as well as your business objectives.
a. Make sure you have a working understanding of your profit margin on each product or service you sell.
Know how much the product or service costs you to offer before you establish a price. Do these costs remain consistent, or do they fluctuate? Restaurants that offer high quality meat and seafood often price their meals at “market rates” as opposed to fixed rates. Calculate the fixed and variable costs associated with your product or service. You will want to work the cost of the product or service, a percentage of your overhead, and your own profit into the cost of each item.
Do you have mostly high margin, or low margin items? Have your variable and fixed costs increased since you set your prices? Have you added items to your product or service mix that have impacted the sales volume on the rest of your items?
b. Establish what your business objectives are, and how your pricing strategy can assist you in achieving them.
Your pricing strategy should be purpose focused. What exactly are you trying to do by setting your prices at certain levels? Are you looking for:
- Short-term profit increase
- Long-term profit increase
- Customer generation
- Product positioning
- Revenue maximisation
- Increase margins
- Market differentiation
If you don’t know exactly how a pricing strategy can help you achieve these objectives, that’s okay. I’ll show you in an upcoming section how to connect your business vision to a concrete formula for pricing.
c. Review your corporate values and how you are planning to position your company in the marketplace.
How do you want your target market to view your business, and your products? Are you trying to create an image of high quality? High value? Reliable service? Make sure your pricing is consistent with the image you are trying to project. If you are operating a high-end spa – you’re not competing with the budget nail salon down the street, so your prices should be considerably higher.
2. Create a list of the factors that influence your prices
When you worked through the exercise above, you likely came across a number of factors that ultimately helped you determine where you set your prices in the first place. Unfortunately, it’s never quite as simple as product cost plus margin equals total cost. You have to take an overall look at your costs in order to price each item. There are a number of things that will influence what the final price is:
- Fixed costs. Overall, this will affect how much you charge for products and services as you’ll have to build a percentage of this total into the cost of each item.
- Variable costs. This will affect pricing primarily on an individual product level, as each product will cost a different amount, or take a different amount of resources to produce.
- Competition. This is obviously a big factor in your pricing strategy. Depending on the size of your competition, and the number of competitive businesses in your area, this may be the primary factor.
- Company objectives. As I mentioned above, your business vision will help dictate what your pricing strategy will be. If you are trying to penetrate a new market, or move old product, your prices will have to be set accordingly.
- Uniqueness. How unique is your product or service? Highly unique offerings will have less competition, and more freedom in terms of pricing.
- Positioning. Similar to your company objectives, how you want your business and your product to be viewed plays a part in how much your offering costs.
- Target market and willingness to pay. The amount your target audience is willing to pay for a product or service is also a huge factor. If they can’t afford to buy your products when you’ve accounted for costs and a healthy profit margin, you’ll need to look for a new market or reconsider your offering.
- Factors beyond your control. This includes government and industry regulations, as well as professional associations that regulate services. Health companies will offer a maximum amount of coverage on health and dental services, so if you price beyond that range you could be losing a bunch of potential clients who won’t pay out of their own pockets.
4. Create a new price structure based on those factors and using these pricing strategies:
Once you know what you want to do with your pricing, and what factors you need to consider, it’s time to decide what strategies are the most appropriate for your business.
Remember that you don’t have to use the same strategy for your entire product or service line. You may be trying to compete with a competitor on one line of products, and position yourself as a high-end reseller of designer goods with another. The best approach here is to group products or services into sections, and apply a pricing strategy to each group.
a. Here are some helpful guidelines to follow when creating your overall strategy:
- Price higher than cost. This may seem obvious, but ensure that your pricing not only covers your costs, but potential fluctuations in sales volume and in the marketplace. If you sell half of your order, will you still make a profit?
- Include expenses. If you price to cover your costs, will you also be able to cover your expenses and still see a profit? Your margin needs to pay for your expenses, leave you with something to live on, plus some working capital for the company.
- Consider the ‘fair’ price. What do your consumers think is ‘fair’ for each service or product? This is impacted by your competitor’s price, your company’s image (high quality or high value, low cost), and the perceived value of your product or service.
- Avoid the lowest pricing strategy. The days of the lowest price guarantee and pricing wars are over – especially for small businesses. The “big players” in the marketplace will quickly put you out of business if you try to compete on price. Their pockets are deeper and they have lower operating costs due to their sheer size. They can afford to – you can’t.
b. Here is an extensive list of potential pricing strategies for you to use as a reference:
Cost Plus Pricing. This is the most basic pricing strategy. Set your price at a number that includes the total cost of goods or services (based on a specific sales volume), a percentage of total expenses, plus a markup, or profit margin. This is the opposite of competitive pricing. Instead of looking at the market, look at your own cost structure. Decide the profit you want to make and add it to your costs to determine selling price.
Target ROI Pricing. Determine your price based on a targeted ROI. For example, if you need to make 10,000 from 200 units (£/$ 50 per unit) then you’ll need to set your price at £/$ 50 more than cost (including expenses).
Value Based Pricing. This is where you price your product or service based on a benefit or value that it will afford the customer later. For example, for an item that costs you £/$ 35 to product, but will save the customer£/$1500 to £/$2000, a £/$100 to £/$200 price tag will seem reasonable.
Positioning Pricing. As I discussed above, the level at which you set your prices will say something to your customers about the quality of your products and your business. What message are you trying to send the customer? Are you a high-end spa? Or discount car rental store?
Competitive Pricing. Set your prices using your competitor’s prices (retail or wholesale) as a benchmark for your own. Depending on how you are trying to position your product, price slightly higher or lower than theirs.
Loss Leader Pricing. This is where you sell an item at or below cost to draw customers, who will then buy additional high-profit items. This is a short-term strategy, usually used as a promotion, when you know your customers usually buy more than one item at once.
Close Out Pricing. Use this strategy to move old or excess stock. You can sell these items at a discount to avoid the cost of continuing to store or display the items that were slow moving or over-ordered.
Versioning Pricing. This is where you set the price of the base model, and then offer several other “versions” of the same product with additional upgrades and features. This is how most car companies sell their product.
Penetration Pricing. If you’re trying to increase your market share, this is the strategy for you. Typically, the business would set their prices very low to attract customers and build their database. Then, once the customers have been converted, the prices begin to rise, justified with high value and customer service.
Skimming Pricing. Most technology is priced this way. A new product is released at an initially high price, and then the price is slowly lowered to include a larger market base. You’re trying to get as much profit from each market “layer” as possible. The initial high price is not sustainable, but is initially justified by the product’s novelty.
Premium Pricing. If the product or service has a high level of uniqueness, or additional value, price the item accordingly high. You’ll need a competitive advantage for this strategy to work, or your competition will take your business with lower prices. This is the strategy to use for luxury and designer goods or services.
Economy Pricing. This is your basic, no frills low price. Works well for economy brands in grocery stores and drugstores. The cost of making or purchasing the product is kept low in comparison to other products available.
Captive Product Pricing. If you sell items that require exclusive consumable parts (like razors or printers), set the price of the original item low, and charge a premium for the consumable parts. For example, the latest razor model is priced around £/$10, but replacement cartridges are priced at £/$12 for four.
Geographical Pricing. If you import products from different parts of the world, your prices will need to reflect this increased cost and your marketing will need to position the product as unique to justify the increase in price. Also called rarity value.
Be sure to test and measure your pricing strategy, and make changes where necessary.
Inevitably, when you increase your prices you’re bound to lose some sales volume. However, as long as your price increase makes up for the lost volume in the short term, your strategy is a success. On the other hand, if you have increased some of your prices and those products are still flying off the shelves, you may want to consider a second increase in a few months.
If you have a purpose based pricing strategy, like a penetration pricing strategy, you will need to evaluate if you are achieving your objectives. In the case of penetration pricing, you will need to evaluate if you are increasing your market share with the price you have set. In this case, you would be able to measure the success of your efforts by looking for an increase in sales, as well as an increase in customers who have come to you from the competition.
Let me know if you have any questions!