How you price can have a dramatic effect on your sales, cash flow, and profit margins. Your pricing strategy will determine how customers see your trade business in the marketplace – naturally comparing your prices with your competitors.
What you need to know to build a profitable pricing strategy
The prices you charge will influence how customers respond to your products or services. Pricing can mean the difference between success and trading at a loss. Consider the following two pricing factors.
What the market says
You can gain valuable guidance by conducting research on your target market’s reaction to similar products or services to your own. Ask yourself:
- Which products or services are offering the best value to customers?
- Which are likely to be the most successful?
- What do customers expect to pay for them?
- Is there an established market price for similar products or services?
Compare the risk for buyers on each product or service you research. If you can reduce or reverse your offering’s risks, you could charge a higher price.
What your competitors are doing
To some degree, your price will depend on your competition. Look at your competitors for:
- The key benefits and features they offer.
- Any points of difference you can see in your own offerings.
If you’re able to offer more, you can afford to charge a higher price. For example, if you’re an electrician, you might be able to add more jobs to a package deal that your customers value above your competitors’ offerings.
One widespread strategy is to charge on purchasing volume. One-off sales carry higher costs than repeat business, so regular customers are more valuable and might justify lower prices.
In contrast, customers who always demand special services will always be less profitable – unless you charge them higher prices to justify the cost of meeting their needs.
Cost-plus is a necessary starting point to avoid under-charging. Simply calculate all your production costs and add the amount you need to make a profit.
However, cost-plus doesn’t consider:
- The level of demand.
- What competitors charge.
- Market expectations, or what customers expect to pay.
Consider these issues before making your final pricing decisions.
Benchmarking your costs
Reviewing changes in your costs is important. It becomes even more useful if you can benchmark your costs against industry averages – like gross profit and net profit margins. If your margins are below industry norms, this could suggest your costs are too high or your prices are too low.
Industry margins also give you a rough guide to the prices you could achieve when introducing new products. Consult your accountant for help with benchmarking figures.
Looking at price differentials
Varying prices can increase your profitability. For example, you could:
- Charge lower prices for high-profile products to capture customers who will also buy higher margin products, also known as a ‘loss leader’ strategy.
- Charge different prices at different times to reflect changing demand.
- Charge different prices for different levels of service or specification.
Most accountants warn against discounting. Once you work out how much extra you need to sell to cover a discount, their concern becomes understandable. Therefore, you never start a discounting battle against stronger or more established competitors – nobody wins except the customer.
However, discounting can work in certain circumstances. For example, clearance discounts can help you:
- Sell off old stock.
- Release working capital.
- Improve cash flow.
Also think about setting prices at attractive ‘price points’ such as $49.99 instead of $50.
Deciding to increase your prices
Increasing prices (and therefore margins) can sharply boost your profits – even if your turnover drops. However, you should always explain to your customers why you’re increasing prices and give them fair warning.
Use each price change as an opportunity to re-enforce the benefits your product or service offers. Positive relationships with your customers can help to improve their value perception and the risk of them trying alternatives.
Frequently review your prices
Review your prices regularly to ensure you’re keeping up with trends in your industry and the overall market.
Any changes in turnover can signal a pricing problem or an opportunity. For example, if you sell products with high or growing market share, you could increase prices. Similarly, if you pitch or tender for business and your success rate is high, you may be underpricing.
If both your margins and market share are low, you need to change something – or consider discontinuing certain products or services. Try limited time, trial-price changes to give you valuable information at reduced risk.