Deciding on pricing for your products or services is one of the trickiest decisions you'll make as a business owner. It's also one of the most crucial components to your future success (or failure).
Why is pricing so important?
The price you charge for each product or service you offer has a direct effect on your sales revenue, profits, brand image, and future business growth. Setting your prices above or below their optimal value can have drastic consequences for the success of your business. Let's take a look at what can happen if your prices aren't where they should be.
What happens if my prices are set too high?
Let's say you're cooking up some homemade cat treats to sell at the pet bakery you just opened downtown. You're confident that you've got the "purrfect" recipe nailed down, so you set your price at a whopping 17.99 for an 8-ounce bag. You want to maximize your profit, so why not set your prices high?
People start coming into your store following your grand opening, but only a few people choose to buy your new cat treats. You decide to offer free samples, and even though the local cats seem to dig your treats, their owners aren't pulling out their credit cards. Guess what, you just priced yourself out of your market!
You might think your mouth-watering cat treats are worth 17.99, but your market clearly would prefer to buy them elsewhere for a much lower cost. Even though your profit margins per transaction are high, your total sales revenue is abysmal because not many transactions are taking place. You should've done some market research before setting your prices so high!
What happens if my prices are set too low?
Now let's say you call it quits on the whole cat treat operation and come up with a new plan - you're going to sell "Corgi Cannolis". The cat treat catastrophe demonstrated the detrimental effects over-pricing can have on sales, so you've come up with a new strategy. You're going to set your Corgi Cannoli prices low, a meager $0.49 per cannoli, to sell as many as possible and get people talking about your new product!
You run a few online ads for your cannolis, and sure enough, people start buying your products. You sell through your entire first batch in the first three days, only to realize you barely made any profit. That's because your prices are set too low, and you didn't take the COGS (Cost of goods sold) into consideration.
A few days later, one of your employees tells you that they saw people talking online about how they don't trust the quality of your Corgi Cannoli ingredients. The low prices delivered a perception of inferior quality to your market, and they would prefer to purchase treats for their four-legged friends at a higher price. Even though your ingredients might be of high quality, the perceived value your potential customers see in your products is what matters! Under-pricing can harm your profit margins, brand image, and can attract a client-base that isn't ideal for your brand.
We realize that you might not be selling cat treats or Corgi Cannolis (and if you are, then all the power to you!), so here are five tips that can help you correctly price any product or service!
1) Take a look around you
Performing some basic market research is relatively easy to do and will set you on the right track for pricing your products/services. Take a look at what similar businesses in your area are charging. Figure out what the highest and lowest prices in your geographic location are; your prices will likely fall somewhere in between.
2) Figure out your target market's demographics
Who are you aiming to sell your products/services to? Where are they located, what is their income range, and how much money do you think they would be willing to spend on your offerings? You can also perform a survey by asking people who match your target audience criteria what prices they would willing to pay for your offerings. Just remember that survey responses can be biased so always take them as suggestions, not as absolute facts.
3) Calculate how much sales revenue you need to keep your business running/growing
Creating a financial game plan for your business can be challenging, but it's a crucial part of setting yourself up for success. You have to take into account all of your business costs (including fixed costs and variable costs), and a projection of how much revenue you would make at various price points. You also want to think about how much money you want to make at the end of the year after all of your expenses are subtracted from your total revenue. Below is a simple formula you can use to get started.
4) Ask yourself "how can I create more value for my customers?"
The more value a customer sees in your products/services, the higher price you will be able to charge! There's two main types of value - "actual" value and "perceived" value. Luxury brands like Rolex and Coach are excellent at creating perceived value, and part of this is due to their high pricing strategies. So in a way, perceived value can increase prices, and prices can also increase perceived value.
One of the best ways to increase value for customers is through quality service. Amazon, for example, creates an immense amount of value for their customers through customer service, fast and free shipping, convenience, and a wide variety of products. You don't need to be on Amazon's level to apply some of these ideas; just figure out what types of value you can offer your customers to justify your prices!
Pro Tip: Remember that only one seller can win the low-price game. Trying to maintain the lowest prices in town can be a futile battle, especially for small businesses trying to compete with developed supply chain structures of stores like Wal-Mart. Instead, you should focus on making a better, unique product that entices people to choose you over your competition!
5) Test different prices and measure the results
Like any other aspect of marketing, testing different variables is essential to optimizing your profits and success. You don't need to make any drastic changes to your prices either, just try moving them slightly up or down for a short period of time and see how your sales revenue responds. Make sure to measure the results so you can analyze what worked and what didn't!