One of the keys that open the door to entrepreneurial success is setting the right price for your product. If chosen correctly, it can increase sales volume and help you create a basis for a prosperous venture. A bad pricing strategy, on the other hand, can stagger your business plans to a halt even if you have a great product with huge potential. Experienced consultants from the South Moravian Innovation Centre (www.jic.cz) prepared a few tips on how to walk this dangerous line.
In business, there are various pricing strategies and as per usual, there is no universal model that fits all. Different types of products, enterprises or markets need their own approach. To determine the right price, you need to consider several key factors including the target customer, the pricing policy of your competition, and the relationship between quality and price.
How to determine the price of a product: 5 things you need to consider
The first step is to be clear about what you want to achieve with your pricing strategy. The obvious answer is, “Make money!” After all, this is probably one of the reasons why you rushed into doing business. You should look one step deeper, though, and define what exactly that means: ideally, you should be generating enough revenue from the sale of products, so that you not only cover your costs, but also make a profit – preferably in such an amount that allows you to expand the business.
There are many methods and instructions on how to correctly determine the price. Successful companies use a combination of different tools and know that the factor around which everything revolves is, always and foremost, the customer. The more you know about your customer, the better you can offer them what they value. The higher value, the larger sum you will be able to charge them.
1) Know your customer
To determine the price correctly, you need to know how sensitive your customer is to price, what value your product is for them, and what other alternatives they think are available on the market. Conducting market research is essential for getting to know your customer.
2) Calculate it
The basis of pricing is, on one hand, the costs that are associated with the creation of your product, and on the other hand, the profit that you expect from the product. In other words, what margin you need for the product and how much of it you need to sell to make a profit.
Do not forget that the cost of the product also includes overhead expenses. That can include fixed costs, such as rent, and variable costs, such as transportation or storage fees. You must include these in the estimate of the actual price of the product.
A good rule of thumb is to make a table of all the costs you cover each month, which may include the following items:
- actual costs of products, including labour, marketing and sales costs,
- all operating costs,
- salary (yours),
- finance for the expansion of your business.
The total amount of costs should give you a good idea of the gross revenue that you will need to generate to ensure that all the necessary expenses are covered.
3) Know your competition
It’s really rather useful to look at the competition when pricing. After all, this is exactly what your potential customer will do. Are there any products comparable to yours? If so, you can use their prices as a benchmark.
4) See where the market is headed
You’ll probably never be a prophet. But you can monitor external factors that might affect the demand for your product in the future. They can range from something as simple as long-term weather patterns to planned legislation, both of which can influence future sales of your products. Also, pay attention to your competitors and their actions. Is there a competitor that might respond to your launch by engaging in a price war with your company?
5) Monitor profitability
Your work doesn’t finish by setting the price once and for all. On the contrary, continuous monthly monitoring is a must. And not only by looking at the overall profits produced by the whole company, but the profitability of each product that you sell.
Poor pricing carries risks
At the beginning of your pricing process, let’s acknowledge the risks that come with poor decisions.
Price Too Low
Setting your price too low can have a disastrous economic impact. Many novice entrepreneurs initially feel that their product is yet unknown and therefore it should be cheaper than competitors’. But the problem with this approach is that customers attribute value to your products based on its price. As soon as you increase it more significantly, there might be uproar.
A frequent reason for underestimation is also poorly calculated costs. The revenue from the sale of products must, in most cases, cover your fixed and variable costs, not only the cost of producing the product. And on top of that, you should also take into account the estimated costs once you hire first employees or rent an office.
And, don’t ever forget your personal reward. Implement it into the price from the beginning, even if you plan to reinvest the money back into the business.
Price Too High
Overestimating the price of a product can be just as harmful as underestimating it. The buyer will always look at the prices of your competitors. Setting a price beyond what the customer is willing to pay can reduce sales and therefore your overall profits. Put yourself in your customer’s shoes. What would seem like a fair price to you?
One more unsolicited advice at the end – have an action plan drawn up. A pricing plan that goes three to six months into the future. Have something to hold on to. You can, of course, adapt it as life starts making other plans for you, but you will at least have a solid base to fall back on. Luck favours the prepared. And in business, this is true twice as much.
This text is based on a Czech article written by Vít Hanák, see original at jic.cz. Pictures by Jiří Lubojacký.