Every cent you add to
your prices goes straight to your bottom line. So it’s important to make sure
you’re not selling yourself short.
Deciding how to price your products or services can be a challenging. Although
there are principles to follow, it's not an exact science. It may take time to
discover what works best for your business.
Covering your
costs
Before working out pricing you need to understand your costs. They fall into
two categories:
-
Fixed costs
The essential costs of doing business, including rent, wages, interest and
utilities.
-
Variable costs
Costs that go up and down depending on sales volume, including the cost
price of a product (or an hour’s wages, for a service business).
Your break-even
point is the point where your sales exactly cover your costs.
Setting a
strategy
Once you understand your costs, you’re ready to set your pricing strategy.
Here are five essential questions to answer:
-
What is your unique selling proposition?
Is it price, quality, service or convenience?
-
How sensitive is your market to price changes?
Can you increase prices without losing business? Or will a small reduction in
prices increase sales?
-
Are you running a high turnover or a high margin business?
This will determine whether you can produce the highest profits with a low
price or a high price strategy.
-
What are your best customers willing to pay?
The value of something in a free market is simply the amount that a buyer is
willing to pay. Your aim is to charge what the market will bear.
-
What return are you targeting?
Make sure your pricing structure can generate the return on investment you
want.
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What are
you really selling?
Before setting a price for your products and services, understand what
you’re really selling. What's your unique selling proposition that keeps
customers coming back?
Here's an example. A man who ran his own food services business was asked to
advise a petrol company on pricing at their service station convenience stores.
He found they regularly discounted bread and milk — their biggest sellers —
even though they were usually bought by men on the way home from work.
Convenience stores sell convenience, which people will pay for. Instead of
discounting, they could have charged a premium.
Once you understand what you're selling, you can charge accordingly.
Price for
profit
When you set prices, the aim is to maximise profits, not sales. This can
mean charging a higher price, even at the risk of turning customers away.
If you’re running a low margin, high turnover business in a competitive
market (e.g. a supermarket), you’ll want to drive sale volumes as hard as you
can. But many small businesses can do better by focusing on their most
profitable customers and offering a value-added service with a higher
margin.
The dangers of
discounting
Discounting can be a great tool to get new customers or to free up cash you
have invested in unsold stock. But you must do the numbers first and work out
how many sales you need to break even.
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Top
five pricing mistakes
-
Forgetting to pay yourself
Don't treat your time as a free resource. Include your salary and owner’s
distributions in the price you charge, and pay yourself accordingly.
-
Cutting prices to win business
If you have to cut prices to win a customer, are they a customer you
want?
-
Confusing mark-up with margin
A 50% mark-up on your cost of goods doesn’t mean a 50% margin. If you buy a
widget for a dollar then sell it for $1.50, your profit is 33%, not 50%. And
that’s before taking your other costs into account.
-
Forgetting the full cost of labour
Labour costs aren’t just salary. Don’t forget leave, public holidays, payroll
tax and super.
-
Discounting without doing the numbers
Discounts to turn over stock can be effective but you must know how many new
sales you need to compensate for the cut in profits.
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