Running a Small Business
Lesson 1: Setting Prices
Setting your prices
Setting your prices correctly for your particular business situation is very important for the success of your small business and for reaching the financial goals you have set for yourself. In a typical market you'll be competing against large businesses and other small businesses like yourself. Fortunately, no two businesses are identical so that you always have advantages and disadvantages. The key is to identify them and set your prices accordingly but always fairly.
A good example is location. If yours is a locally based business, which means that you draw your customers from an area around your place of business, and if you're the only one in the area, then that is an advantage. It becomes a strong advantage if zoning or other factors prevent anyone else from opening a similar business in the same area. In that case you don't have to compete on price but you still want to keep your eye on the competition so that your pricing remains competitive for your privileged situation. You have to put a value on your customers not having to drive outside the area and you can have your prices reflect that extra value but your overall pricing level must still be seen to be reasonable by your customers.
So, you've got your costs and your advantages. If one of your advantages is that you can offer your product or service at a lower cost than anyone else and your low cost competitors are financially weaker, mark your cost up by a small profit margin and advertise your lowest cost offering which should be lower than anyone else's. In that situation it is a sure-fire way of being successful, at least until someone figures out how to undercut you.. In all other situations, you have to decide on the value your target customer would put on your particular advantages. The take the average selling price of your product or service in your target market, add the value of your advantages and you've got your market price.
But you're not finished yet. Your market price reflects a fair price for the product or service you're offering in your target market. Now back to your costs. Compare and decide if you can live with the market price you have come up with. It should normally cover your costs and leave a margin - your profit. This is the check on your entire business concept. If the market price doesn't cover your calculated costs, then something isn't quite right. Are you paying too much for materials? Are you paying yourself too much? or is your office over-equipped so that your overhead is too high. This is something you need to find out and resolve before you can approach that target market successfully.
If your costs are more or less in line, there are two more things you have to look at.
- How price-sensitive is the product or service you're offering in your target market. As an example, gasoline is very price sensitive - people will drive for long distances to get a few cents off. Motor oil is not price sensitive. People can buy it in for less than $1.00 a can but will pay much more to have it put into their engine at a full service gas station. Find out the price range for your product or service - it's good indication of price sensitivity.
- You have to know the price sensitivity to be able to take this next step. You will want to price slightly above or below the market price you've calculated, depending on whether you want your business to generate profit or to grow as a priority. If your price is lower, it will grow faster with less profit - if your price is higher, it will generate more profit but grow more slowly. How much your price should be higher or lower is determined by the price sensitivity. If your product or service has a low price sensitivity, then you have to raise or lower your price quite a bit to achieve your goals; if price sensitivity is high, a small price difference has a big effect.
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