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Price your offer too low, and you leave money on the table. Price it too high, and you can say goodbye to sales that could have made your year.
Finding the ideal price means choosing a pricing strategy that’s appropriate for your company’s circumstances.
“How much the customer is willing to pay for the product has very little to do with the seller’s cost and has very much to do with how much they value the product or service they’re buying,” says Eric Dolansky, Associate Professor of Marketing at Brock University in St. Catharines, Ont.
The 5 most common pricing strategies
Cost-plus pricing. Calculate your costs and add a mark-up.
Competitive pricing. Set a price based on what the competition charges.
Price skimming. Set a high price and lower it as the market evolves.
Penetration pricing. Set a low price to enter a competitive market and raise it later.
Value-based pricing. Base your product or service’s price on what the customer believes it’s worth.
Finding your ideal price
So how do you get to an ideal price, the “sweet spot” that will deliver the most profit given your circumstances?
Effect of price on price
As you raise your price (moving left to right), your profitability goes up—to a point. It’s at the point where you’ve raised your price by too much that your profitability goes down.
Source: Eric Dolansky
“Pricing is one decision that shouldn’t be driven by accounting,” says Dolansky. He says that arriving at an ideal price means taking into account factors that some entrepreneurs may overlook.
When considering your price, it’s important to realize that it’s not for yourself, but for your target customers.
Finding the right price range
Your customer needs to find that your price falls within their range of what’s acceptable, and your ability to price is constrained by your costs.
In the chart below, the floor of your pricing is your total costs for what you’re selling. The ceiling, or highest price, is the number at which your customer values your offer. Above this price, you lose the sale because the customer feels that your price exceeds the value he or she gets from your offer.
Between the floor and ceiling sits a price your customer will find acceptable.
Price floor and price ceiling.
Source: Eric Dolansky
To choose the right price within your customer’s acceptable range, consider the main factors that affect price:
- operating costs
- scarcity or abundance of inventory
- shipping costs
- fluctuations in demand
- your competitive advantage
- perception of your price
Choosing the right pricing strategy
1. Cost-plus pricing
Many businesspeople and consumers think that cost-plus pricing, or mark-up pricing, is the only way to price. This strategy brings together all the contributing costs for the unit to be sold, with a fixed percentage added onto the subtotal.
Dolansky points to the simplicity of cost-plus pricing: “You make one decision: How big do I want this margin to be?”
The advantages and disadvantages of cost-plus pricing
Retailers, manufacturers, restaurants, distributors and other intermediaries often find cost-plus pricing to be a simple, time-saving way to price.
Let’s say you own a hardware store offering a large number of items. It would not be an effective use of your time to analyze the value to the consumer of each nut, bolt and washer.
Ignore that 80% of your inventory and instead look to the value of the 20% that really contributes to the bottom line, which may be items like power tools or air compressors. Analyzing their value and prices becomes a more worthwhile exercise.
The major drawback of cost-plus pricing is that the customer is not taken into consideration. For example, if you’re selling insect-repellent products, one bug-filled summer can trigger huge demands and retail stockouts. As a producer of such products, you can stick to your usual cost-plus pricing and lose out on potential profits or you can price your goods based on how customers value your product.
