- Your actual product costs, including labor and the costs of marketing and selling those products.
- All of the operating expenses necessary to own and operate the business.
- The costs associated with borrowing money (debt service costs).
- Your salary as the owner and/or manager of the business.
- A return on the capital you and any other owners or shareholders have invested.
- Capital for future expansion and replacement of fixed assets as they age.
List the dollar amount for each on your spreadsheet. The total should give you a good idea of the gross revenues you will need to generate to ensure you cover all those costs.
Know Your Revenue Target
You should also have a revenue target for how much of a profit you want your business to make. Take that revenue target, factor in your costs for producing, marketing, and selling your product and you can come up with a price per product that you want to charge. If you only have one product, this is a simple process. Estimate the number of units of that product you expect to sell over the next year. Then divide your revenue target by the number of units you expect to sell and you have the price at which you need to sell your product in order to achieve your revenue and profit goals.
If you have a number of different products, you need to allocate your overall revenue target by each product. Then do the same calculation to arrive at the price at which you need to sell each product in order to achieve your financial goals.
Know Your Competition
It's also helpful to look at the competition -- after all, your customer most likely will, too. "Are the products offered comparable to yours? If so, you can use their pricing as an initial gauge," Willett suggests. "Then, look to see whether there is additional value in your product; do you, for example offer additional service with your product or is your good of perceived higher quality? If so, you may be able to support a higher price. Be cautious about regional differences and always consider your costs."
It may even be worthwhile to prepare a head-to-head comparison of the price of your product(s) to your competitor's product(s). The key here is to compare net prices, not just the list (or published) price. This information could come from phone calls, secret shopping, published data, etc. Make notes during this process about how your company and products -- and the competition -- are perceived by the market. Be brutally honest in your evaluation.
Know Where the Market Is Headed
Clearly you can't be a soothsayer, but you can keep track of outside factors that will impact the demand for your product in the future. These factors can range from something as simple as long-term weather patterns to laws that may impact future sales of your products. Also take into account your competitors and their actions. Will a competitor respond to your introduction of a new product on the market by engaging your business in a price war?
Dig Deeper: When Customers Grumble about Price Hikes
How to Price Your Products: Deciding to Raise or Lower Prices
One size does not fit all. You can only go so far pricing all your products based on a fixed markup from cost. Your product price should vary depending on a number of factors including:
- What the market is willing to pay.
- How your company and product are perceived in the market.
- What your competitors charge.
- Whether the product is "highly visible" and frequently shopped and compared.
- The estimated volume of product you can sell.
That opens the door to raising and/or lowering prices for your products. In order to make this call one way or the other, you should first understand what's already working. Analyze the profitability of your existing products, so you can do more of what works and stop doing what doesn't work. You want to find out which of your existing products are making money and which are losing money. You may be surprised at how many of your products are losing money -- fix those ASAP.
You should also constantly re-evaluate your costs. To sell it right, you have to buy it right. If you are having a hard time selling a product at an acceptable profit, the problem may be that you are not buying the product right. It may be that your cost is too high rather than your price is too low.
When to Raise Prices -- and How
You should always be testing new prices, new offers, and new combinations of benefits and premiums to help you sell more of your product at a better price. Test new offers each month. Raise the price and offer a new and unique bonus or special service for the customer. Measure the increase or decrease in the volume of the product you sell and the total gross profit dollars you generate.
It is a fact of life in business that you will have to raise prices from time to time as part of managing your business prudently. If you never raise your prices, you won't be in business for long. You have to constantly monitor your price and your cost so that you are both competitive in the market and you make the kind of money you deserve to make.
"The best way to determine if the product is being priced correctly is to watch sales volumes immediately after making any change," Willett says. "This can be done by watching cash collections (if the business is cash or credit card based) or credit sales (if accounts receivables are used) for the weeks following. If a price increase is too high, customers will react pretty quickly. Also watching the competition can help - if you've made a positive change in prices; competitors are likely to follow suit."
But there is a right way and a wrong way to raise prices. You don't want to alienate your existing customer base by raising prices too steeply, especially during a recession. "Rather than have a sudden increase, have a strategic plan over two to five years during which you gradually increase your price 5 to 10 percent," Toftoy advices. "If the business is in trouble and you say, 'Hey, I'm going to mark everything up… that kind of scares people away. This way you haven't gone from $5 to $15. You've gone to $7.50 first."
"In terms of raising the price -- this is more easily accepted in 'good' economic times," Willett says. "As the underlying cost of producing the product rises, the customer is prepared to accept the rise in the price to them. If the customer perceives that the firm's costs are going down while their price is going up. This will not be received well and is likely to backfire."
When to Lower Prices -- and How
You may realize that you have missed your target audience by pricing your products too high. You can always choose to discount your products or give customers something for free in order to get them to try your product or generate traffic to your storefront or website. "You have to get people in," Toftoy says. "People like getting something for free or some kind of discount. You can make Wednesday senior citizen day when seniors get a 20 percent discount. Then maybe you can offer a student discount day. Then all you're doing is keeping the price the same, but to those people you're giving them a cut but it's not like you've lowered all prices."
Generally, lowering prices is not a good practice unless you are using this strategically to garner market share and have a price sensitive product or if all of your competitors are lowering their prices, Willett says. "An alternative to lowering price is to offer less for the same price which will effectively reduce your costs without appearing to reduce the value to the customer," she says. "Restaurants have found this particularly helpful in terms of portion sizes but this same strategy can be applied to service industries as well."
Monitor Your Pricing
Another key component to pricing your product right is to continuously monitor your prices and your underlying profitability on a monthly basis. It's not enough to look at overall profitability of your company every month. You have to focus on the profitability (or lack of profitability) of every product you sell. You have to make absolutely sure you know the degree to which every product you sell is contributing to your goal of making money each month. Remember: "People respect what you inspect."
Here are some other practices to help you price right:
