Pricing products or services correctly is a crucial function of a business owner. But how do you go about doing that consistently and fairly?
Pricing obviously plays a large role in whether a business is profitable. The difference between your selling price and the cost of a product is the “contribution margin.” The contribution margin pays for all other expenses and then after that, some profit. Even if sales are high, you may still find there is no money left at the end of the month. This lack of cash can be from expenses that are too high, but many times it is because you do not have an effective pricing strategy. The difference between sales and profit is found in your pricing policies.
Some small businesses use the manufacturer’s suggested retail price. It is an easy strategy to use but it may not be right for you. It may create an undesirable price image and it doesn’t consider the competition’s pricing strategies.
Another tactic is pricing based on the competition. This is where many small businesses get in trouble — trying to compete with the mass merchandiser. Many of these “giants” can sell at retail for less than you can buy at wholesale. So while you may generate a great deal of revenue, you may be losing money with every product you sell.
You can price below the competition but this also reduces the profit margin per sale. This strategy requires careful monitoring and the ability to react quickly.
You can price above the competition – when price is NOT the customer’s greatest concern. Many people find their time much more valuable than saving a few dollars. Target your business at these individuals, not the bargain hunters.
The key to success is to have a well-planned strategy, establish your policies, monitor costs and evaluate your effectiveness. The formula is simple: Sales less cost of goods less overhead expenses equals profit.
Marcia Bagnall is Director of the Chemeketa Small Business Development Center and instructor of Small Business Management Program. This column is produced by the center. Questions can be submitted to SBDC@chemeketa.edu. Visit the SBDC at 626 High Street NE. or call (503) 399-5088.