Question: In a recent column you discussed some basics of how to price my goods and services. So what's next?
Answer: There's a lot more to know about pricing. Let's talk about this.
Quick review: When we discuss pricing in this context, we're talking about determining a gross profit margin for a particular product or service. And, pricing depends on numerous considerations: the type of product or service, your cost(s) to provide it, the competition (both direct and indirect), the consumer environment and many other factors. Also, you need to consider your expense structure and work on setting an overall pricing strategy for your business.
A common mistake - especially in the early stages of a retail or service business - is pricing very low in order to attract new customers. While special deals can start the ball rolling, there's a problem. Low prices can draw customers interested primarily in price and they are the ones most likely to abandon you the moment they find a lower price elsewhere. Pricing too low can mean little or no profit. And be careful about using additional discounts, coupons or promotions; these could result in your selling below cost, without realizing it.
On the other hand, a high-margin pricing strategy can stifle sales and also create a price image problem (this is disparagingly called "retail plus ten percent").
Note there is a difference between setting the price of individual items and services, which is what we're talking about here, and choosing your "price points." The latter refers to the actual dollar prices (not the profit margins) of your offerings. To illustrate, a furniture store could have very expensive goods (high price points) but sell at low 20 percent margins. Conversely, a gift shop might price items at under $100, but have 60 percent or higher margins.
The three most common pricing methods are cost-up, market-based and value-added.
The cost-up method is used primarily in manufacturing. An entire group of bean-counters known as cost accountants specialize in this exact area. The objective is to identify every dollar that goes into making a particular product. This includes all the direct costs to make the item (materials, labor, machinery), and then also adds the indirect or allocated costs like factory overhead. Management then decides how much to mark up the cost figures, how to set a pricing structure based on the quantity being sold (a "price sheet") and other matters. Sounds very formal, but even if you sell something you make in your garage, you should follow this model.
A market-based pricing approach is very common for retail and many service businesses. Obviously the biggest factor in how you price your offerings is to look at what choices your target customers have, or in other words evaluate the competition. If you can differentiate your goods or services in some favorable way, you may be able to charge more. This is called your "unique value proposition."
Consumers are not totally price-driven: they will pay more if they feel they are getting something in return. Several examples: personal attention; a clean shopping environment; extended hours; or unique services.
The value-added pricing approach is common in specialized services and a few other business situations. It asks the client to recognize that your work is exceptional and worth a premium. Examples:
• A medication which adds greatly to the quality or duration of later life is valued (priced) many times higher than the actual cost to make it.
• One could argue that a law firm's contingency fee is value pricing; it's high value-added to the client, who would otherwise get nothing.
• A geotechnical engineering consultant who locates a major ore vein is value-billing for more than just his hourly fee.
Five other interesting pricing models are:
• Freetailing: Give a sample product or service away for free, hoping for a future purchase.
• Gillette theory: Sell a cheapo necessary hardware item at or below cost; make it up in mandatory, proprietary consumables. The shaving razor has turned into the inkjet printer.
• Free service to all, others pay for ads: This is the Internet standard, where third-party "click through" ads pay for the service.
• Anticipation pricing: You sell the base unit, say an upscale motorcycle, at a fair price, and then have profitable long-term upgrades and customization sales to the buyer.
• Membership club: Collect an annual fee to belong to, and shop at, the club's stores.
In summary, pricing is largely psychological, and it is an art. In a future column we'll talk about the reasons why people buy.
ABOUT SCORE
To learn more about managing cash flow, and other small business matters, contact SCORE, "Counselors to America's Small Business." SCORE is a nonprofit nationwide organization with more than 13,000 volunteer business counselors who provide free, confidential business counseling and low-cost training workshops to small business owners. Call the local SCORE chapter at 360-685-4259 to schedule an appointment. For details about the organization,visit SCORE.org.
