How much should I charge? Figuring out pricing in your small business
Rhonda Abrams is one of America’s leading small business experts. Her business plan guide, Successful Business Plan: Secrets & Strategies, was named one of the 100 best business strategy books of all time. She has also started, built, and sold four businesses. She was educated at UCLA and Harvard University and lives in Palo Alto, CA.
An old joke: A store owner purchases pencils for 10 cents apiece, then sells them for a nickel each. Noticing this bizarre behavior, his partner asks, “How do you expect us to stay in business that way?” The man replies, “Volume!”
Surprisingly, many small business owners try to follow a somewhat similar business strategy. They imagine that all that’s necessary for success is to price their products or services cheaper than the competition. Low prices, they assume, will generate enough sales to keep them in business.
Competing on price is a risky business, particularly for a small business. While Amazon and Walmart built thriving businesses on low prices, it doesn’t work for a company with limited cash reserves. Low prices almost always mean low profits. With a small financial cushion, you’re vulnerable with every slight increase in costs. The landlord raises your rent by 5%? That may be your entire year’s profit.
Moreover, customers attracted solely by price are fickle. They shopped around before choosing you; they’re going to keep shopping around. And you’re easy pickings for your competitors—if you become a serious threat, they can just undercut your prices and wait until you’re squeezed out of the market.
While low prices shouldn’t be the cornerstone of your pricing strategy, how do you set prices in your small business so that you find that “sweet spot”—the place where you make a healthy profit but stay competitive and attract and keep customers?
There are some proven pricing strategies. They include:
Do your research
Know what’s happening in your market before you set your initial prices. That can be a fairly easy task if what you’re selling is similar to something already being sold, especially if prices are easy to discover, such as a consumer product. Finding out prices from competitors can be much harder when you’re offering a service. One good source of pricing information can be industry associations. And, if you can do so without misrepresenting yourself, you can call other providers to find out what they charge. One way to do this is to call similar services in other cities that don’t see you as a competitor.
Understand your costs
Here’s the first rule of all business: you have to make a profit if you want to stay in business. If you don’t recognize how much it costs you to make and deliver your product or service—including overhead as well as inventory or materials—then you can’t set a meaningful price. Try, as best as you can, to understand what your total costs are, so you can figure out how much you’ll need to charge to make a profit. Of course, when you first start in business, you may charge less than what would make you a profit, just to learn the business and establish a customer base.
Consider different pricing models
Regardless of how much you charge, there are a few standard models of how to charge. It’s worthwhile to consider these different models when deciding on your prices. The most common pricing models are:
- Fixed prices. You may have sales or discounts, but the price is generally established.
- Hourly pricing. This is typical with professional services (such as lawyers and accountants) and many contractors.
- Project pricing. You negotiate an agreed-upon price before the start of a specific project, with payment dependent on completion. This works best with a clear statement of deliverables.
- Dynamic pricing. The price changes depending on demand. This is now typical in airline prices and, frequently, in sports and concert tickets.
- Introductory pricing. You charge a lower price to attract customers, but over time, the price goes up. This is a good way to lower customer resistance to making a purchase to get them to try your offerings. Just be sure you are clear that the price is only being offered for a limited time.
- Subscription pricing. Customers pay you a set amount, typically monthly or annually. Almost all digital services, including software applications and streaming services, are priced this way, as are ‘memberships’ such as gym memberships. Subscription pricing is widely considered “the holy grail” of pricing since customers typically have to take action to STOP paying you.
Offer different price points
Ever notice how virtually all services have some kind of ‘basic,” “standard,” and “premium” levels of service? That’s because giving customers three choices is just about right for everyone. Some customers always gravitate to the most expensive, some to the cheapest, and the majority to the middle. Consider how you can offer small, medium, and large versions in your business, too. For example, a wedding videographer could offer a “standard” service taking photos at the wedding, “pro” would include post-production editing, and “premium” would include advanced editing and creation of a deluxe wedding album.
Carve out a niche
If you are seen as someone with specific expertise or knowledge that appeals to a particular segment of the market, you can set higher prices and have fewer competitors. It’s a win/win! See if you can find a way to target a niche market, such as a specific industry or demographic group, and learn their specific needs. For example, if there are 100 mechanics in your city, you’ll face constant price competition. But if you’re the only mechanic specializing in Volvos, or even European cars, you’ll face much less price pressure. And you’ll be far more attractive to Volvo owners!
Target the right customers
Not all customers are willing to pay more for better quality. Target your marketing efforts at those who can appreciate the differences you offer. This doesn’t just mean marketing to upscale customers. There are value-conscious, not just cost-sensitive, customers at every income level. It means making certain your marketing materials focus on the other positive ways you are different from your competitors, beyond price.
Build loyalty to you, not your price
Even if you initially attract customers through discounts, introductory prices, sales, specials, or lower prices, make sure you work to develop the kind of relationship that keeps customers coming back even when the price goes up.
Test different prices
You’re probably not going to set your prices right immediately from the start of your business or when you launch a new product or service. So, to help get you meaningful feedback, test out a number of different price points. A good way to do this is online—by placing search or social media ads that are similar except for the price and seeing what you get.
Focus on value, not price
Value is a term used to describe the combination of price and quality (or convenience). Many customers look for good value, not just low price. When you shop for a winter coat, you may be willing to pay higher prices to get quality that will last many years. Likewise, a client may be willing to pay a higher price for your services if you can deliver the job faster with higher quality than your competition. Excellence and service are true competitive advantages enabling you to build in higher profit margins.
The price is right
Remember, setting prices is more of an art than a craft. Large companies spend fortunes on consulting firms that specialize in pricing strategies, so don’t be surprised if it takes you a while to find just the right price to charge in your small business.