Solving the Pricing Puzzle
Setting prices for products and services should be simple, shouldn’t it? Cover your costs, make a profit, and appeal to customers. But there are more variables to the pricing formula than many new small business owners may realize.
“When you’re starting out, you may not have a good handle on all the costs you’ll incur,” observes Janet Attard, founder and owner BusinessKnowhow.com. “Unless you have previous experience estimating jobs in the same industry, you may have difficulty making accurate estimates of the time and/or materials needed to complete jobs. You also may not account for non-billable hours—the time you spend marketing and promoting the business.”
Other costs of doing business may also be overlooked—until you have to pay them. These include payroll and self-employment taxes, fees for accepting credit cards, health insurance and other benefits, and a variety of overhead expenses.
Yet even after all those costs are accounted for, a seemingly fair price may not gain traction with customers. “Prices are market-driven, not cost-driven,” explains former executive and veteran SCORE counselor Lou Davenport. “It doesn’t matter what your costs are because the market doesn’t care. What matters is if you can make a profit at price the market with bear.”
A valuable tool for pricing is the SBA Guide, Pricing Your Products, which Attard says, “does an excellent job of discussing basic price setting criteria, and includes some worksheets to help make sure you do account for all your costs.”
Davenport also recommends researching industry benchmarks for Gross Profit Margins, data that can be found on-line or at a nearby SCORE office. He also cautions new entrepreneurs to avoid the frequent mistake of under-pricing their products and services in order to lure customers.
“Rather than getting a toehold in your business, you’re actually giving competitors an advantage, because there’s no way you can survive for the long term and meet your clients’ expectations by pricing under the market,” he says. “Instead, set prices based on what the market will bear.”
Attard also says, “Discounting can lower the perceived value of the product or service, or make the customer think you lack the experience/resources to do the job. If you underestimate costs, or overestimate the volume that will be sold, the outcome will be reduced profits or a loss.”
Once you do establish a reasonable pricing structure, make it a point to review it several times a year. With the easy availability to find cost information, customers and competitors are watching pricing trends, so don’t risk being left behind.
“You want to spot cost increases and other problems early on and make appropriate adjustments to continue making a profit,” Attard advises. You also need to stay on top of market trends; if prices and demand are rising or falling, you can determine how to stay competitive.”