Ask people to pay too much for your product or service and they will stop buying; ask too little and your profit margin slides or customers assume your product is poor quality. An “optimum price” factors in all your costs and maximizes your margins while remaining attractive to customers. Here’s how to set it.
- Know the market. You need to find out how much customers will pay, as well as how much competitors charge. You can then decide whether to match or beat them. Simply matching a price is dangerous, though – you need to be sure all direct costs will be covered and that there’s enough “fat” left to cover indirect cost.
- Choose the best pricing technique. Cost-plus pricing involves adding a “mark-up” percentage to costs, which will vary between products, businesses and sectors. Value-based pricing is determined by how much value your customers attach to your product. Decide which approach is most suitable for your products before making a calculation.
- Work out your costs. Include all direct costs, including money spent developing a product or service. Then calculate your variable costs (for materials, packaging and so on); the more you make or sell, the higher these will be. Work out what percentage of your fixed costs (overheads such as rent, rates and wages) the product needs to cover. Add all of these costs together and divide by volume to produce a unit breakeven figure.
- Consider cost-plus pricing. You will need to add margin (“mark up”) to your breakeven. This is usually expressed as a percentage of breakeven. Industry norms, experience or market knowledge will help you decide mark-up. If the price looks too high, trim your costs and reduce the price accordingly. Be aware of the limitations of cost-plus pricing, because it works on the assumption you will sell all units. If you don’t, your profit is lower.
- Set a value-based price. You’ll need to know your market well to set a value-based price. For example, the cost to bring a hairdryer to market might be £10. But you might be able to charge customers £25 if this is the market value.
- Think about other influences on price. How will charging VAT have an impact on price? Can you keep margins modest on some products in order to achieve higher margin sales on others? You might need to calculate different prices price for different territories, markets or sales you make online. Selling at odd values (for example, £9.99) rather than whole pounds is common.
- Keep on your toes. Prices can seldom be fixed for long. Your costs, customers and competitors can change, so you will have to shift your prices to keep up with the market. Keep an eye on what’s going on and talk to your customers regularly to make sure your prices remain optimal.