Pricing your products or services can be very tricky. Setting prices too high will scare off customers, but pricing too low will throw away potential profits. Here’s what you need to know about this delicate balancing act.
Three things will affect how you price your services or products:
Pricing starts with knowing your costs.
If you’re in retailing, these would include the stock you buy in. If you provide services, these would include materials, fuel, expendable items, etc. You’ll probably need to work out different options for your variable costs, which take into account stocking and selling varying numbers of units, or providing differing hours/days of service, or using differing amounts of materials. And don’t forget to include VAT in your costings if you’re registered.
It’s very easy to overlook costs, so make sure you take account of all of these, including credit card fees, fees for professional services, such as accountants and solicitors, pension costs, salary, etc.
Adding your fixed costs to your variable costs gives you a breakeven figure – the amount you need to generate simply to cover your costs before you make any profit.
A traditional way of pricing is cost-plus. This is done by adding a ‘mark-up’ to your breakeven figure, usually as a percentage that depends on your industry sector. This mark-up is your profit.
An advantage of cost-plus pricing is that you can work this out based on information you have close to hand.
Disadvantages of cost-plus pricing for a retailer are:
Conversely, cost-plus pricing can lead to under-charging, for example. if you don’t face much competition you can probably charge more.
You need to decide which end of the pricing scale you fit. Are you in the business of piling things high and selling them cheap, or do you provide exclusive and expensive products or services? Or perhaps you’re somewhere in-between?
There’s no one right approach – it depends on the nature of your business and the products or services you sell. But whatever approach you take, you need to understand the mechanics of your pricing strategy. For example, if you source a product for £1 and price it at £1.50 you need to sell three times as many to make the same profit as selling it for £4.50.
If you’re providing a premium product or service you can aim for a very high profit margin, but you must ensure that your quality meets, or exceeds customers’ expectations.
Usually it’s better to go in too high than too low. Be ready to reduce your price if you don’t achieve the volume you require. Customers usually react more favourably to a price reduction rather than an increase. If you seriously under-charge in the present, you’re going to have a steep hill to climb in the future to get customers to accept price hikes.
A new business may be tempted to charge low prices in an attempt to build sales. In a competitive environment, an established business may reduce prices to try to maintain sales. But high levels of sales don’t necessarily result in high profitability. Dropping your price can be a risky tactic as there’s usually a competitor who will do things cheaper. Keep your focus on profitability.
Whatever you decide, you should regularly review your prices, and those charged by the competition. Very few prices are fixed for the long-term. And if you find that you’re having difficulties making a profit on an item or service, you need to think seriously about dropping it.
There’s no need to aim rigidly for the same profit margin across different products or services. In fact, having different margins can be a way of attracting and retaining customers.
For example, a tradesperson who charges a justifiably high hourly or daily rate, might add little or no mark-up on materials or parts and use this as a marketing tactic.
In retailing, it’s common to have different mark-ups for different types of products. For example the same business might have different mark-up rates for sportswear and jewellery.
There are a number of online calculators of profit margin, including this one from Calculator Soup.
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