A common pricing tactic pursued by small-business owners is to have the lowest price available. They assume that when customers compare prices, the business will have more customers and sell more units.
And that means making more money, right?
The right price for your product is influenced by many factors that might change over time. So their effects must be monitored and prices adjusted if needed.
It is important to understand how each factor influences your price, but your final decision should be based on evaluating the combined effect.
Do not disregard the effect price has on profitability, not just units sold. Learn how price affects profitability in your business and how to use the mathematical relationships behind this effect.
The relationship between the price of your product and its cost determines your gross margin. For example, if your product costs $10 and your price is $25, your gross margin percentage is 60 percent.
Lowering your price might increase sales, but it decreases your gross margin percentage. The effect on the profitability of your business might be positive or negative, depending on how much the number of units sold changes.
To predict how price changes will affect profitability, you first need to know and understand your costs. You also need to know approximately what your margin should be.
You can learn this by looking at industry averages that can be obtained from sources such as Risk Management Associates, Financial Research Associates and trade associations.
Also consider how your customers may react to changes in price. If you decrease price 10 percent, how much might your units sold increase? Perhaps 10 percent? Or 50 percent? Or none at all?
How many more units would you have to sell at the lower price just to stay at the same profit level? Once you do the math, the number might surprise you.
You also cannot ignore the competition. Know the range of prices your competitors are charging and where you want to fit into that range.
One way to learn about the competition’s prices is to shop the competition yourself as if you were their customer. But plan ahead and know what you want to observe and what questions you want to ask.
You can also learn about your competitors’ pricing methods through observing their ads, visiting their Web sites and attending industry trade shows.
Know how the quality of your product compares to the competition. Understand what your customers value and be able to confidently communicate to them the greater value you offer.
Your price is related to the image you want to convey to your customers. They sometimes believe that products are inferior if the price is low.
Consider how people might perceive the value and quality of a $5 bottle of wine versus a $100 bottle of wine.
Finally, your customers might buy more if you offer price discounts. But discounting too often can cause customers to expect the discounted price all the time, feeling that it is the “real” price.
Sometimes it is better to offer an additional item “free with purchase” instead of discounting your price. This typically costs you less, and people love the idea of getting something “free.”
You can find help with understanding the pricing process at your local Small Business Development Center.
Connie Edwards is a business consultant with the University of Georgia’s Small Business Development Center. Contact her at 651-3200.