Chapter Four: Pricing Your Products and Services
There are several pricing strategies. Select the approach that will make your goods or services the most competitive and will help you reach your profit goals.
Retail Cost and Pricing
A common pricing practice among small businesses is to follow the manufacturer’s suggested retail price. The suggested retail price is easy to use, but it, by no means, adequately account for the element of competition.
Pricing Below Competition
This strategy reduces the profit margin per sale. It requires you to reduce your costs and achieve the following:
- obtain the best prices possible for raw materials or inventory,
- locate the business in an inexpensive area or facility,
- closely control inventory,
- limit product lines to fast-moving items,
- design advertising to concentrate on price specials, and
- limit non-essential services.
One word of caution: pricing goods below the competition can be difficult to sustain because every cost component must be constantly monitored and adjusted. It also exposes you to pricing wars. A competitor can match the lower price, leaving you out in the cold.
Pricing Above Competition
This strategy is possible when price is not the customer’s greatest concern. Factors important enough for customers to justify paying higher prices include:
- service considerations, including delivery, speed of service, satisfaction in handling customer complaints, knowledge of product or service, and helpful, friendly employees,
- a convenient or exclusive location, and
- exclusive merchandise.
This strategy targets a precise segment of the buying public by carrying products in a specific price range only. For example, a store may wish to attract customers willing to pay more that $50 for a pair of shoes. Price lining has certain advantages:
- ease of selection for customers, and
- reduced inventory and storage costs
This approach involves selling a number of units for a single price. For example, two items for $5.99. This is useful for low-cost consumer products, such as shampoo or toothpaste. Many stores find this an attractive pricing strategy for sales and year-end clearances.
Cost Factors and Pricing
Every component of a service or product has both different and specific costs. Many small businesses fail to analyze each component of their commodity’s total cost, and therefore fail to price profitably. Once you do this analysis, set your prices to maximize profits and eliminate an unprofitable service.
Cost components include material, labor, and overhead costs.
Material costs are the costs of all materials found in the final product, such as the wood, glue and coverings used in manufacturing a chair.
Labor costs are the costs of the work that goes into manufacturing a product. An example would be the wages of all production-line workers producing a certain commodity. The direct labor costs are derived by multiplying the cost of labor per hour by the number of personnel hours needed to complete the job. Remember to use not only the hourly wage but also the dollar value of fringe benefits. These include social security, workers’ compensation, unemployment compensation, insurance and retirement benefits.
Overhead costs are those not readily or directly associated with a particular product. These costs include indirect materials, such as supplies, heat and light, depreciation, taxes, rent, advertising, transportation and insurance. Overhead costs also cover indirect labor costs, such a clerical, legal and janitorial services. Be sure to include shipping, handling and/or storage as well as other cost components. Part of the overhead costs must be allocated to each service performed or product manufactured. The overhead rate can be expressed as a percentage or an hourly rate. It is also important to adjust your overhead costs annually. Charges must be revised to reflect inflation and higher benefit rates. It is best to project the costs semi-annually, including increased executive salaries and other costs.