Setting the right pricing strategy is a crucial process for any business. You need to find a balance between attracting customers by not appearing too expensive whilst offering value for money, balanced with making profit.
Fundamentally, all businesses need to sell products and services at a profit, else the foundation of their business is not sustainable. The basic points you need to consider when setting prices are:
- The prices you charge need to cover your business costs which include the cost of your products and your overheads PLUS the profit you want to make
- If the cost of your products and overheads are too high and are forcing your pricing structure to be too high and uncompetitive, you have to look at ways of reducing your costs
- Regularly review the prices you have set to keep up with changing prices like utilities, petrol, postage etc. You will find it easier to explain to customer that because of changing costs, you need to regularly increase your prices by a few percent each year than do a much larger price jump every 5 years.
To be able to set your prices, you need to understand the costs of your business. This includes everything you pay money for – property and rent, utilities, bank charges, loan repayments, leased equipment of cars, cost of running your office or warehouse, materials, wholesale goods, salaries, staff commissions etc. It is also important to take your profit into account at this stage too. If you want to make a minimum of £1000 profit each month, then add it as a ‘cost’ to the business and work out your pricing strategy with that taken into account. You are not in business to breakeven.
One of the simplest ways to calculate pricing is to work out your cost of materials, add to that the cost of all your overheads, then add on the profit you want to achieve.
For example, if you were setting up a sandwich delivery round, your pricing calculation for each sandwich would look something like this:
|Cost of materials (bread, fillings, wrappers)||£0.80|
|Cost of labour to produce the sandwich (hourly rate of the sandwich maker divided by the number of sandwiches they can make in an hour)||£0.40|
|Cost of overheads (add up all the costs of the business each month e.g. sandwich making facilities, sandwich van, utilities, salary of your sandwich delivery person etc and divide them by the number of sandwiches made each month)||£0.50|
|Total cost of making one sandwich||£1.70|
|30% profit margin you’d like to make on every sandwich [1.70 MULTIPLIED by 0.3 in your calculator]||£0.51|
|Minimum required sales price for your sandwich||£2.21|
Other considerations when setting prices
Perceived value of your product
As a small business, your costs will be more than a larger competitors as the volume you are buying your materials in are lower. To continue the sandwich example on, you would initially be buying your materials from a wholesaler, Bookers or Makro for example. The volume you would be buying your materials at would be relatively low volume hence you would need to buy from a wholesaler and not direct from the bread or ham manufacturer who would be looking for a certain volume before they sold to you directly.
This would mean your cost of sandwich making materials would be higher than a larger competitor such as Subway who would by buying materials at such a large volume and making sandwiches on such a massive scale, they will always be able to set their prices lower. In fact, the irony might be that you would need to buy some of your materials from a sandwich making competitor such as Tesco (who also make and sell sandwiches) because they might sell a loaf of bread cheaper than a wholesaler would due to the volume of bread they sell to the public in general.
So how can you charge £2.21 for a sandwich that someone might be able to buy in Subway or Tesco for cheaper? You have to ensure your perceived value of your product is higher. How?
- Your product needs to be better – more filling, better packaging, fresher, local or organic ingredients etc
- You need to offer a better service – a convenient delivery mechanism like delivery to the door, a friendly chat with every customer, made to order service, promotions such as ‘Free Crisp Friday’ to loyal customers etc
- Your brand needs to be stronger – give people reasons to want to buy from you; you are local, you are independent, you are friendly, you use organic locally sourced ingredients, you always smile etc
Flexible payment structure
If you are selling a product or service to any business, then taking the buyers financial situation into account is key. Obviously you are not to know how much money they have in the bank but offering different payment terms will allow the buyer to feel they are in control.
If you run an accountancy firm that specialises in doing end of year accounts for self-employed people, you could offer a one-off charge of £300 each year or a monthly direct debit of £30 so the payment is spread out for the customers over the year (and ultimately you are making £60 more from each client).
From a completely different perspective, larger companies might find larger one off payments easier to handle. If a Marketing Manager has their own credit card, then a one off payment for a service will be easier for them to manage than speaking to the businesses accountant to get the companies bank details and to arrange for a direct debit payment to be set up.
A classic technique in some industries is to provide multiple product options which allows the consumer choice but also the retailer to upsell. It often proves very effective when there is an emotive reason for purchase. For example, a typical technique when selling flowers online, is to have three sizes of bouquets. The company promotes the cheapest so the consumers sees the bouquet they like and the price is ‘from £20′. When they go to add the bouquet into their basket, there are three price options: £20, £25 and £30, and the highest price one will be automatically selected. The consumer then needs to make a conscious decision to ‘spend less’ on the person they are buying a gift for, a sneaky tactic as they are playing with emotions. A few will select the £20 option as that is the price they original intended to spend, some will leave it at £30 and just move on with the order, but the majority will settle for the middle option as the middle option is always perceived as a ‘safe’ option and they feel like they have regained control by selecting the price they want to spend. The flower companies would say they are providing customers with a range of spending options, but most would say it’s a sure fire way of increasing the average spend per customer by £5.
It’s pretty bad form to keep prices hidden from consumers. Be very clear as to whether the prices you are quoting do or don’t include VAT, ensure there are no extra charges for using credit cards and be upfront about any additional delivery charges. If you are advertising monthly prices but charging for a year up front then tell the consumers at the start, don’t keep it a secret as keeping prices hidden from consumers is a guaranteed way to lose a customer for good.