Running a Small Business

Lesson 1: Setting Prices

Your Competition

You can set your prices based on your costs and leave them there but it's kind of like flying blind - you've set your course and you're going to stick with it but you have no idea what obstacles, cross-winds or other planes are out there ready to interfere with your plans.

What your cost-based calculation does is tell you how much it costs to bring your product or service to market. With production cost and overhead you haven't added in any profit yet but you are paying yourself going rates for work performed. As far as pay is concerned, you're being paid for work but there's no extra for expansion, contingencies or retirement.

To avoid flying blind, you've got to look at your market. In addition to the groups to whom you want to sell there are your competitors who also want to sell to the same groups. When you look at your market, you want to find out what the product or service you're offering is selling for and how it compares with your pricing. Typically, in an active market, you will find competitors who are selling both above and below your cost price.

So, how can a competitor sell below the price you've calculated which doesn't even have any profit in it yet? It could be that this competitor is selling at a loss. It could be that he's not paying himself anything, which essentially amounts to the same thing. It could be that he doesn't have your quality. But, it could be that he's found some way of doing what you're doing but better and less expensively. In any case you should only try to compete on price if you're sure that his costs are higher than yours, that he's losing money and that he can't keep that up for very long. In all other cases undercutting a low-price vendor will not be good strategy for a small business.

Let's look at the other side of the coin - how do the businesses charging more than you get customers. That's both easier to understand and also easier to compete with. They offer either better quality, better service or they make the customers believe that they have received something extra. They are selling to customers who value the better quality, the better service or the perception that they receive something extra, whether they do or not. That's where you have to take your small business unless you have an inherent cost advantage. You have to identify groups of customers who will pay extra for what you can do and it helps a great deal if it's something that you can do better and less expensively than anyone else.

Now you've got everything you need to set your prices.

• your production costs;
• your overhead, say for one year;
• your projected sales for one year;
• the price range for your product or service in your target market;
• your pricing strategy - low price or high price with special qualities but always good value for your target customers.

Review your financial goals for your business again because you want to set your prices as low as possible while still reaching those goals. As always, you want to give your customers the best deal you can.

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