Small business marketing tips includes knowing if your price is right for your market. Here, Maria Laino gives us some great ways to think about how you price your product so maximize profits.
By Maria Laino
Why does a hamburger cost $10 when you order it at a restaurant, but only $3 when you order it to-go at McDonald’s? Prices seem so random—do business people just wake up one day and decide how much customers should pay and that’s the end of it? Pricing may be arbitrary for some, but if you want your business to stay alive and thrive, it has to be deliberate.
Once a business identifies its value proposition and segments the market to find a target audience, it is time to start pricing.
Pricing is more than the amount of money you charge for a product or service. It also includes discounts, terms of payment, and the payment period you set.
This article will help you learn how pricing affects the Profit & Loss statement.
You will also learn about the three benchmarks that help you set prices: they are costs, competition, and the market.
Finally, we’ll take a look at how combining the first two marketing tips (value propositions and segmenting the market) with pricing helps you create a sturdy marketing foundation for your business.
Pricing and the Profit & Loss Statement
The price you choose for your product or service directly affects your revenues, or sales. You can calculate your revenues by multiplying the number of units you sell by the price of each unit.
Revenues = Unit Price x Number of Units Sold
If the price of your product or service is too high, customers will demand or purchase less of your product. This drives revenues down. On the other hand, if you price too low or discount too heavily, you will cut into your gross margin. Gross margin is total revenues minus total costs.
Revenues – Costs = Gross Margin
If you lower the price you may sell more units, but the revenues will not be enough to cover your costs. The lower price does not cover the costs, even though you sell a higher volume. Here’s another way to look at the gross margin calculation:
(Price x Units) – Costs = Gross Margin
We see from the P&L how important it is to set the right price. But how do you know what that is? Next, we’ll look at the three pricing benchmarks to find out.
The Three Pricing Benchmarks: the Market, Competition, and Costs
a) The Market
The prices you set depend on the value your business offers and what the market will bear. Customers perceive value in every experience they have with your business: from discovering it, to purchasing, to using the product. To your customers, prices are the costs of obtaining value from your business. Depending on the market and the level of value you offer, customers are willing to pay higher costs or prices. In order to set the price, you need to understand what value you offer and what customers are willing to pay for that. Here’s our article on building an unbeatable value proposition.
You can price based on how your competitors price. When observing the competition, it is important to look not only at the money they charge for their products or services, but also at the value they offer. This will help you understand exactly what the competition offers and at what cost to customers.
The best way to learn about your competition is to become a customer. Open an account. Check out the competition’s website. Ask a question or send an email. See how responsive they are. Buy something small to see if the order comes as planned. Once you gain this information, compare your value proposition to your competitors.
If what you offer is unique or better, you can charge similar or higher prices than your competitors and still have strong revenues because customers will value your business over the competition.
The third benchmark is costs. Under this method, the price should be equal to the cost of providing the good or service plus 40% of the cost.
Price = Cost + 40%
In order to do this, you must know what your true costs are. For a product, you must calculate how much it costs to obtain the raw materials, how much it costs to hold inventory, and how much it costs to raise capital.
For a service, it can be tricky to determine your true costs. In this case, you must evaluate how much time it takes to deliver work and what that time is worth.
If you cannot set the price at a minimum of cost plus 40%, you will not be able to stay in business because your revenues will not cover your costs and you will lose gross margin. Here are a few potential causes of this problem:
You may have a weak value proposition. Customers are not interested or do not demand what your business offers.
Customers may not know what your value proposition is. In this case, you need to educate them or help them discover what you do and why it matters.
Your costs may be too high. Consider alternative components or processes to keep the unit costs lower.
You may have targeted the wrong audience. The group of customers you are marketing to may not appreciate your value proposition. Try to find another segment of the market that does.
Value Proposition + Market Segmentation = Higher Revenues
When your business has a “dynamite” value proposition that is unbeatable and you have targeted a specific audience who loves what your business does, you can charge higher prices. Customers will gladly pay premium prices because they cannot find what your business offers anywhere else. This is the goal—to compete not on price, but on the things you do well and that are beneficial to your customers.