Pricing considerations based on your type of business
Developing a pricing strategy is one of the most difficult aspects of operating a business because there are no hard and fast rules. Your main goal should be to focus on profits. As long as you cover your costs, it is up to you to determine the best pricing strategy for your business. Sometimes the type of business you run will affect the way you set your prices.
No matter which pricing strategy you choose, it is a good idea to review it on a regular basis to ensure that you are not overlooking any new factors or hidden profits.
As a manufacturer, your production costs will be at the base of your prices. These costs include labour, materials and all other expenses associated with the production of your goods. You will also factor in your overhead expenses. These are the regular expenses that it takes to keep your manufacturing facility running, such as rent, utilities, insurance, etc. A general rule is to set your price in such a way that it covers both production costs and your fixed overhead, while allowing for profit.
Price = production costs + overhead + desired profit margin
It is likely that your production process will eventually be affected by economies of scale. As demand for your product increases, so will your production. However, your costs could decrease if you are able to buy your materials in larger quantities and, therefore, at a better price. You will be spending more, but the unit cost of your product will go down as you sell more.
If you manufacture a unique product, you are in an enviable position. As its only producer, you are able to set your prices as you please, with a view to maximizing your profits. However, you probably have competitors, so if you choose to set prices that are much higher than theirs, be prepared to explain this strategy to your employees and your customers. If you can convince others consistently that the value of your product is worth its price, then there is no reason to avoid this strategy.
Retailer or wholesaler
As a retailer or wholesaler, you depend on manufacturers to supply you with the products you sell. Your price to the customer will reflect the price you pay your suppliers, plus your overhead and the profit that you would like to make on the product.
Price = product costs + overhead + desired profit margin
Again, there is no set formula that will guarantee the best price for your business. Sometimes you might hear that the wholesale price is 1.5 times the production costs and the retail price 2.5 times the production cost, but this percentage will vary greatly, depending on the product and the market. Even within your business, you may choose to work with a variety of percentages that you use to markup different products. Staples such as groceries might have much less of a markup than clothing or luxury goods.
There are a number of ways you may price your products:
- Standard markup — This formula is based on a set markup (price = cost + markup percentage). When you use this formula, you don't usually consider market conditions or your competition. The advantage to this method is its simplicity.
- Break-even — How many units must you sell in order to make a profit after the break-even point?
- Anchored pricing — This method is based on what the competition is charging. If you see that customers are willing to pay this price, you may decide to adjust your price down slightly. Because the initial price (your competitor's) has been anchored in the customer's mind, your price now looks very appealing.
- Match market expectations — This method is based on the idea of supply and demand, or what the market is able to bear. You can make more profit in a good market, when demand for your product is high, and then lower your prices if necessary.
- Prestige pricing — You may charge higher prices to impart an image of higher quality or greater value.
Because you might not be the only retailer or wholesaler working with the products you sell, your pricing decisions are likely to be influenced by the market and your competitors.
If you provide services as part of your business, you have to make pricing decisions based on less tangible matters. How much are your time and skills worth?
Services can be difficult to price because it is hard to compare them with accuracy. However, there are certain standard items for you to consider, such as costs. This will include your overhead, as well as any supplies or services you have to subcontract. Build in a profit margin.
It is always practical to find out what your competitors are charging. Perhaps your industry association publishes rate guidelines. Use a variety of resources to do your research and find where you fit within the range. What value can you offer to your clients in order to charge more?
It is important to keep your clients from encountering any surprises when they receive your invoice, so make sure they are aware of your pricing structure and have a realistic expectation of the final bill.
Will you bill per project, charge a daily or hourly rate, or a combination of both? You could create a rough formula to determine your rate. How much do you need to make on an annual basis to cover your costs and salary? Divide this number by the days you can realistically expect to be working on billable projects. Once you include vacation days, sick days and days set aside for marketing or administrative activities, you may find that you are not faced with as many days of paid work as you might have thought.
Even once you have established a pricing strategy, keep up your investigations into how much your competitors are charging for similar work. This will keep your pricing current. At the same time, increasing your expertise and level of skill can ensure that you bring added value to the service. Can your clients afford not to use you?
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