for small businesses
Before setting prices, you
must understand your market, distribution costs and competition.
Remember, the marketplace responds rapidly to changes in supply.
You must keep abreast of the factors that affect pricing and be
ready to adjust or justify your pricing based on other factors.
This is your pricing strategy
This Financial Guide does not
attempt to be an in-depth discussion of pricing analysis. Rather,
it is intended only to provide a basic review of the several
pricing strategies — and perhaps encourage you to take a fresh
look at your present strategies. Professional financial guidance
will be helpful in working up and evaluating the financial aspects
of the analysis for your financial resources.
A common pricing practice among
small businesses is to follow a standard pricing formula. The
standard formula price is easy to use, but it does have one major
shortcoming; it doesn't give you an advantage over your
An alternative to the standard
pricing model is to base your price on those of your competitors.
A small company, for example, should compare prices with a company
that's comparable in size and customer volume.
Instead, price products based on
a local company analysis, then highlight other competitive
factors, like personalized customer service and convenient
location or some other differentiator. There are any number of
factors that influence a consumer's decision to buy from a certain
business, including price, convenience, and courteous and
Some companies have been
successful by pricing their goods or services below the
competition. Since this strategy reduces the profit margin per
sale, it requires a company to reduce its costs and:
- Obtain the best prices
possible for service or product
- Minimize your overhead costs
- Monitor labor and inventory
- Limit the service to those
services that are typical
- Produce advertising that
concentrates on pricing
One word of caution: Pricing
goods below the competition can be difficult to sustain. Why?
Because every cost component must be constantly monitored and
adjusted. It exposes a business to pricing wars. Also, if you
lower your price and your competitor lowers his price, then
neither are making as much but without any competitive
This strategy is possible when
price is not the customer's greatest concern. Considerations
important enough for customers to justify paying higher prices
- Service considerations,
including delivery, speed of service, satisfaction in handling
customer complaints, knowledge of product or service, and
helpful, friendly employees
- A convenient or exclusive
- Exclusive merchandise.
Multi-level pricing involves
selling a number of units for a single price—for example, X
number of hours for $XX or Y number of hours for $YY. Many
companies find this an attractive pricing strategy for encouraging
Every component of a service has
a different, specific cost. Many small firms fail to analyze each
component of their commodity's total cost, and therefore fail to
price profitably. Once this analysis is done, prices can be set to
maximize profits and eliminate any unprofitable service.
Cost components include material,
labor, and overhead costs:
Remember, do not only include the
hourly wage but, also the dollar value of fringe benefits. These
include social security, workers' compensation, unemployment
compensation, insurance, retirement benefits, etc.
- Material costs are
costs of all materials found in the final product. For
example, the wood used in the manufacturing of a chair is a
- Labor costs are the
costs of the work that goes into the manufacturing of a
product. An example would be the wages of all production-line
workers producing a certain commodity. The direct labor costs
are derived by multiplying the cost of labor per hour by the
number of personnel-hours needed to complete the job.
Overhead Costs are any
costs not readily identifiable with a particular product. These
costs include indirect materials, (e.g. supplies) utilities,
depreciation, taxes, rent, advertising, transportation and
insurance. Overhead costs also cover indirect labor costs, such as
clerical, legal and janitorial services. Be sure to include
shipping, handling, and/or storage as well as other cost
Part of the overhead costs must
be allocated to each service performed or product produced. The
overhead rate can be expressed as a percentage or an hourly rate.
This is a complex task.
It is best to consult with an
expert in this area. It is important to review your overhead costs
periodically. Charges must be revised to reflect inflation and
higher benefit rates. It's best to project the costs quarterly,
including increased executive salaries and other projected costs.
Your price structure and policy
are major components of your public image and are crucial to
securing and keeping your clientele.
Pricing for service businesses
may be more complex that retail pricing. The equation, however, is
the same: Cost + Operating Expenses + Desired Profit = Price
The key to success is to have a
well-planned strategy. Establish your policies and constantly
monitor prices and operating costs to insure profit. Accuracy