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This is an excerpt from our Marketing Menu podcast which you can listen to alongside. If you wish to subscribe we produce podcasts every two weeks on Wednesdays and we are available on iTunes, Stitcher, Blubrry and TuneIn. To learn more look at our dedicated podcast channel which includes shownotes at www.themarketingmenu.com
One of the hardest things to wrestle with when setting up a business is arriving at the right pricing strategy, and unfortunately, there is no one size fits all.
Three things to be mindful of are:
- What your product or service will be worth to your customers – its value.
- What it costs you to produce your product or provide your service.
- The price your competitors charge.
Successful businesses maximise their profits by matching their pricing with the value customers put on their products or services. Whereas product pricing is often built on a ‘cost-plus’ basis, while service pricing is created on perceived value, so to arrive at either of these you have to understand:
- The cost is the total outlay required to create a product or service.
- The price is your financial reward for providing the product or service.
- The value is what the customer thinks the product or service is worth.
Whatever your pricing structure you have to understand your cost structure provides a basis for what you need to charge. But it will not necessarily show you what you can – and should – charge.
One way to look at this is by dividing your costs into different things:
Firstly, divide your costs into two headings: variable and fixed.
- Variable costs will increase when your sales increase (e.g. goods and materials).
- Fixed costs remain largely constant, regardless of how much or little you sell (e.g., rent, salaries, business rates).
As long as the price you sell at is higher than the variable cost, each sale will make a contribution towards covering fixed costs – and make profits. Based on this cost structure, you can assess the consequences of different price levels. However, this method is just making sure you cover your costs and provide some income so its very subjective and you have to ensure that you understand your costs over time, take account of future needs and know what costs are likely to go up as well as down.
This brings us to markups which is the bit that’s going to make you a profit and is usually arrived at based on two elements:
- The markup you must add to the cost to make the desired profit, and
- The markup used by competitors usually expressed as a percentage of costs.
- But first ensure all your costs have been factored in before applying the mark-up.
If the final price looks uncompetitive, review the size of the markup. But try not to obliterate the markup to make the price competitive.
And also bear in mind that different products and businesses apply very different mark-ups.
But be aware that this pricing structure does have some pitfalls:
- Cost-plus pricing ignores the image and market position you will be aiming for.
- It also ignores the demand for your product or service.
- Then there’s always the possibility that some hidden costs get forgotten, making true margins lower than you expected.
- Common oversights include holiday pay, depreciation, and costs of handling waste for example.
- Cost-plus pricing also assumes you will achieve your sales target to break even or better.
- And, of course, further down the line competitors can lower their prices to win business from you by either reducing their cost base or working on lower margins.
So when pricing your product and service, you need to look at those all-important fixed costs and variable costs and break that down over the number of clients you want to have or the number of products you want to sell. Then once you understand these, you need to keep in touch with what your competitors are charging, remembering though that they will have different costs to you and that they may be adopting any number of pricing strategies. And finally, you need to consider the value you are adding to your clients or products: is it convenience, is it knowledge, is it reputation, whatever – because this is very much going to underpin the stories you’re going to tell and the way in which you’re going to build your credibility story.