When setting up your business, understanding how to price your product or service is one of the most important things you can do. It can make or break your business. Price too high, and you won't attract enough customers. Price too low, and you'll struggle to make a profit and run a sustainable business.
There are numerous different pricing strategies that businesses can apply from simple market-led pricing (copying a competitor) to more complicated dynamic multi-factor risk-adjusted statistical pricing used by insurance companies and banks. A simple common factor in all pricing strategies is understanding your internal costs. Understanding your internal costs will mean you understand your breakeven point (the point where you can recoup all your costs but make no profit).
We have developed a free, quick and easy pricing tool geared for small businesses which covers 4 main pricing strategies :
- Cost + Time
- Cost + Margin
- Cost + Markup
- Market-led
Cost + Time (aka Cost + Opportunity Cost)
The 'Cost plus Time' strategy lets you account for the full cost of the product you're selling plus the value of your time spent on the product. Essentially you're providing the product at cost price and your profit is the value of your time.
The value of your time can be based on your opportunity cost (the loss of other alternatives when one alternative is chosen). Example: if you're leaving a job paying you £30k per annum to start your business, then your time is potentially worth ~£15 per hour.
This is ideal for skill-led businesses such as plumbers or web designers where you have minimal product costs (material), or bespoke products such as artists or bespoke furniture etc.
Cost + Margin or Cost + Markup
'Cost + Margin' or 'Cost + Markup' are both very similar strategies.
- Markup is how much you want to add on to the cost.
- Example: If your product cost is £15 and you want a 50% markup then £15 + (50% of £15) equals a selling price of £22.50
- Margin (Net or Gross Margin) - is how much you want to be left with in terms of %.
- Example: If your product cost is £15 and you want to achieve a 50% margin, then your selling price will be £30 (£15 / 50%). In this example, your markup calculates to 100%
This is ideal if you know how much profit you want to make. Quite often the margin can be dictated by industry - with fast-moving / cheaper goods having lower margins (eg. 1% to 5%) whereas luxury goods can result in higher margins (eg. 50% to 100%)
Market-led
This is one of the simplest forms of pricing. Seeing what a competitor is charging and then pricing accordingly - either the same or a little higher/lower. The challenge with this approach is that you're not guaranteed to make a profit. Your competitor could be manufacturing the goods themselves whereas you might have to buy them thus a higher cost for you.
Important note
It is important to remember that customers don't care or know which strategy you use. In a price-sensitive market, they only care about the price they pay. For the customer, the perception of what your product or service is worth to them (i.e. the benefit your product or service provides) versus any alternatives must exceed what they pay.
Example: If a customer is only interested in knowing the time then they potentially may not be willing to pay for a £399 Apple Watch when a £15 alternative is available. However, another customer may want the latest and best health-related gadget which also pairs with their iPhone for which the perceived value of that benefit may exceed £399 thus they would be willing to pay that.
The pricing strategy is something to help you ensure you're pricing is profitable and sustainable.
Summary
It's best to put your pricing through as many strategies as possible. It will help you better understand your business, your costs and profitability - so can decide on one or a combination of a few. As part of this process, it is very important to understand your market, competitors and all available alternative products. Be it understanding market characteristics or competitor metrics like popularity, pricing or other trends - &facts is designed to help you better understand your business and your market. Please join our waiting list and we'll make sure you're the first to know when we launch.
