Is budgeting on your mind as you ring in the New Year? While you’re probably focusing on cash flow and managing expenses, it is also important to consider whether or not you are optimizing your pricing strategy for 2024.
Pricing products or services is a complex process. It involves looking at costs, knowing your target audience, researching competitors, and choosing a strategy that works with your profit goals. But whether you are looking to raise prices, price new products, or set prices for the first time, it is worth the time and effort to do it strategically.
And it helps to break it down into manageable steps.
Tips for Determining Product and Service Pricing
STEP 1: Do your homework.
- Evaluate your costs. Start by establishing the cost of your goods or services. Expenses fall into three categories: materials, labor, and overhead. You need to consider all three when computing your total cost.
- Determine your desired profit. “How much should I make per unit?” is a question I hear at least once a week. Your profit goal is somewhat arbitrary, although you can look to professional associations in your industry for guidance.
- Understand your customers. Defining your target audience and understanding what motivates them plays a large role in how you price your products.
- Research your competition. While you may not want to completely mirror the pricing of your competitors, understanding their strategies is essential to developing your own.
STEP 2: Consider these basic concepts and strategies when developing your pricing model.
- What the market will bear (WTMWB). This pricing model charges the maximum (or close to it) for what the market allows. For example, if an item costs $100 to manufacture, and the most a customer will pay for it is $500, this is the market limit. While this strategy can lead to the highest profit margins, it leaves the field open for a competitor to undercut your prices.
- Gross profit margin target (GPMT). Simply put, each item is priced to achieve a certain gross profit. For example, if your targeted gross margin is 40% and your product costs $60, you would need to sell it for $100 to achieve a gross profit of $40.
- Most significant digit pricing. This is why a retailer is more likely to price a product at $19.99 rather than $20.00. Research shows we are more likely to make a $19.99 purchase because our brains tell us it’s a bargain! Ask yourself if this strategy will result in more enticing prices that lead to higher profits.
- Market share pricing. You may offer a product/service at a lower price initially, but as more people use it, your market share grows, and the value increases, you can raise prices. Your ability to develop brand loyalty is critical with this model: a consumer who switched brands once for a better price may do it again.
- Dynamic pricing. Also known as demand pricing, surge pricing, and time-based pricing, this strategy takes into account when and where a product is offered or sold, and whether or not demand for it is on the rise. For example, airlines vary ticket prices depending on factors like seat type and availability, flight time, and destination.
- Competitive pricing. This strategy is common in saturated markets where it’s difficult to distinguish between businesses like grocery stores and gas stations. When a market leader raises or lowers prices, competitors are compelled to follow suit. To charge more than your rivals, you must convince customers that your product/service is superior.
- Value-added pricing. This model targets buyers who are likely to pay a higher price for products or services based on perceived value, such as convenience, status, first-of-its-kind technology, advanced features, or unparalleled customer service.
Some helpful tips for setting pricing:
- Keep your pricing consistent. It’s a small world and people talk.
- Monitor your pricing consistently to ensure it is aligned with the current market.
- Set a minimum price that you will not go below.
Regardless of which pricing strategy you choose, it is not one and done. Don’t just determine it and let it be. Smart business owners monitor prices regularly – keeping an eye on the competition’s pricing and changes in the market and adjusting as needed to help meet profit goals.
