Small Business Blog

In a counseling session a while back, I was asked the question, “What is the right price to charge for my product?”

The typical, quick answer is, “Go find out who your competition is and either match or beat their price.”

However, the more appropriate answer is this:The optimal price is when customers believe they are getting a good deal and are encouraged to buy.

Another way of looking at this is when both parties, the buyer and the seller, feel they haven’t left any money on the table.

To an extent, this is a bit of an idealistic statement. In reality, there are certainly times when the transaction occurs and one party, the seller for example, feels they didn’t get what they wanted and that they could have gotten more for what they were selling, but some outside force was pressuring them to make the sale at a reduced price to satisfy the outside force.

Think of selling a house in today’s economy. You may feel your house is worth more than it really is, and feel that you could get more for it if you had the ability to wait 5 years, but because of an outside force like a job transfer you have to sell the house at a lower price because you can’t afford to keep the house here and move with your new job, so you sell it for less.

Making that disclaimer and setting all of those circumstances aside, there are 3 predominant ways to establish your price.

1. Cost-Up Strategy. With this, you determine what all of your costs are to produce one unit of product or service and mark up your costs by a percentage. If you want to be 10 percent profitable, you figure out what your per unit cost of goods sold (COGS) are and then calculate your overhead on a per unit basis. If utilities are $500 per month and you produce 500 units per month, your utilities per until are $1. Figure this out for every expense you have and add them all to the per until COGS and you have your total cost per unit. Add 10 percent and “presto” you have your price per unit.

While this will ensure that you won’t go broke producing product if all things are equal, it doesn’t take into account the possibility that your COGS and overhead may be at a level that you aren’t competitive in the market place and therefore customers won’t purchase your product, which creates a huge problem because 10% profitability on $0 sales, well it’s not good.

2. Price-Down Strategy. For this strategy, you determine what your competition is charging and figure out how to make yourself profitable at a certain level while charging the same price. My preferred way of determining the competition’s price is hiring a team of corporate spies to infiltrate your competition, earning their trust, and feeding you all of the information via a secure line. Later you can make a move about this hiring Julia Roberts and Clive Owen to play the spies. Maybe this form of “Duplicity” is a little extravagant. I suppose you could also secret shop your competition or ask to see the bids your customer’s have received, but where is the fun in that?

The major concern with this type of pricing is that it depends on your ability to control your costs to a level that may be unreasonable. To sell shoes as cheaply as Wal-Mart does probably isn’t a realistic business model. Economies of scale limit your ability to compete with big box stores and therefore will drive your profits thinner and thinner until you’re broke.

Create Your Own Demand Strategy. Economic theory is that when price goes down, demand goes up, and when demand goes up, volume of sales rise. This doesn’t always happen. Many companies find that if they lower prices, volume stays the same but revenues, margins and profits fall. There is, however a way to break this mold and set your own price by creating your own demand.

If we thought about everything we bought as a commodity, Price-Up and Cost-Down would be the only two choices, but ask any woman if her purses are a commodity, or a man if all power tools are created equal. The truth of the matter is, our perception, and largely our emotions determine for us which product is better. This sense of inequality in a product crosses over to our willingness to pay different amounts for the same product.

Playing on our customer’s perception and emotion can be accomplished several different ways that all derive from what your brand identity is.

If your brand identity is one of ultimate quality, then a premium price can easily be associated with your product. Think of Mercedes compared to Chevrolet. Both have four wheels and a steering wheel. When you step on the gas pedal you go, and the brake pedal makes you stop. So in theory they are the same, but if you pay the same for a Chevy as you do a Mercedes, you either robbed the Mercedes dealership, or got robbed by the Mercedes dealership.

The risk of this strategy is that if you cannot effectively communicate your brand identity, your perception of what your product or service is worth may be miles apart from what your customers are willing to pay.

Regardless of which strategy you employ, make sure you’re aware of the risks and rewards associated with each. While I never enjoy bumping my head on the wall, I absolutely hate bumping my head on the wall because I didn’t take the time to open my eyes and determine where the walls are.

Hopefully this will help open some eyes.

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