How much should you charge for your product or service? How do you know what the right number is? If your prices are too low, you’ll be working really hard for low profit margins. If they’re too high, many of your customers will go to the competition.
Because pricing is an important driver of profitability, getting it wrong can cause a significant dent in your bottom line, and it can make the difference between remaining profitable or going out of business.
The most common mistakes small business owners make when it comes to pricing are usually due to a disconnect between price and value. When you undervalue your product, you set prices that are too low. On the other hand, over-pricing is a sign that your customers do not perceive the value of your product as indicated by your price.
Here are the three biggest mistakes when it comes to pricing:
Pricing based on cost alone
It goes without saying that you should know exactly how much it costs you to offer your product or service. However, this number should only serve as a price floor, not as an overall strategy. While taking your cost and adding a markup may seem like a good idea, this often isn’t the case. The main reason is because this approach completely leaves the customer out of the equation. Buyers don’t care about your internal costs. Just because something is expensive to produce doesn’t mean it is perceived as valuable. On the other hand, something that is inexpensive to produce or distribute (such as software) may be extremely valuable to a buyer who really needs it. When it comes to pricing, customers think in terms of whether something is “worth it” to them. If it is, they’ll buy it; if not, they’ll pass. Aligning price with the perception of value is the key to getting it right.
Pricing based on your competition
The easiest way to set prices is to look at all your competitors’ prices and set your number somewhere between the highest and the lowest. After all, it feels safe to hide in the middle. There are several problems with this approach. For one, very few products or services are exactly identical. Even with products that are commoditized, there are still differences in customer service levels, ease of purchase, technical support, packaging and so on. You need to know exactly how your product is different or better than your competition, and price based on the unique benefits you provide your customers. You also need to clearly communicate those benefits to your buyers, so they understand what they’re getting for the price they’re paying. Last but not least, it is highly possible that your competitors are not pricing their products correctly in the first place, so following their method can wreak havoc on your profitability.
Using a “one price fits all” strategy
This happens when you offer one product at one price to all customers. The problem is that different buyers value your product or service differently based on their own needs and preferences. For example, price shoppers make choices based on price alone. Relationship buyers, on the other hand, are willing to pay higher premiums for the promise of a known and trusted brand. Convenience shoppers are less concerned with either price or quality as long as the hassle factor is minimal. They want an easy shopping experience. What does this mean for your pricing strategy? Price with your customers in mind. For example, movie theaters offer matinee prices earlier in the day. This attracts price sensitive customers who are willing to jump through more hoops in order to save money. Movie goers who prefer to see a show after dinner are OK paying the full price in exchange for maintaining control of their schedule. Using a multi-price strategy means paying attention to the different customer types and providing options that appeal to each segment.
While there is no real test to determine whether your prices are set correctly, knowing and understanding the way your customers think and make decisions will go a long way towards pricing for value. Using a strategic approach when it comes to pricing will help you remain profitable over the long term.
Ileana Tudor is managing director of Tudor Business Consulting in Eden Prairie, MN, offering strategic planning, pricing and marketing strategy services.
Image courtesy Elliott Brown
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