Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
Pricing your products right is a key to success for any small-business owner. But coming up with the right pricing structure can be tricky business. Charging too much can turn customers away, while pricing too low can create demand that your business can't possibly meet. How do you know when your prices are wrong? Here are five signs you need to make a change -- and fast.
1. Competitors are charging more for inferior products.
First-time entrepreneurs often feel they must undercut competitors to win business. That simply is not true, says Tim Smith, managing principal at Chicago consulting firm, Wiglaf Pricing. "Customers don't just buy on price, they buy on value – the value that the product or service offers," he says. If you offer a superior product, price it accordingly. Only if you can produce a product more cheaply and maintain a decent profit should you consider a lower price, according to Smith. He uses the example of 5 Hour Energy, a 2-ounce shot-size drink filled with vitamins and amino acids that retails for $2.99, competing against a well-branded concoction like Red Bull, which comes in a 12-ounce container and retails for an average of $2. "At a higher price than its competitors, with less drinkable volume and a relatively unimaginative brand name, 5 Hour Energy has gone from nothing to nearly $1 billion in retail sales in less than a decade," he adds. "So much for using price to capture customers."
Related: How Pricing Can Power a Turnaround
2. Your storefront is covered with 'sale' signs.
Sales and promotions may boost foot traffic, but are these the customers you want? Companies perform better when they serve the customers who value them, and avoid the customers who don't, according to Smith. "Businesses aren't charities. They don't have to attract every person that indicates a fleeting interest in their offering," he says. Instead, look at the purchasing motivation and requirements of your target market, and set your prices based on how much the customers in that slice of the market are willing to pay. "Customers buy because you provide something they value, not just because it is cheap," he says.
3. Your cash on hand takes a dive.
Cash on hand – meaning all the cash a business has at the time books are closed at the end of the fiscal year-- is one of the best barometers to determine whether prices need to be changed. When your cash on hand drops off from the previous year, it is often because the difference between your costs and the price of your products is getting smaller -- and so are your profits, says Matt Johnson, a partner at Simon-Kucher & Partners, a Cambridge, Mass.-based global consulting firm specializing in pricing and marketing strategies. When your costs go up -- whether it's because your suppliers are charging more or overhead costs are increasing -- your prices should, too. "Most customers have become accustomed to cost-based price increases or surcharges in the past several years," he says. "These increases can be easy if the connection between cost and price is clear."
Related: How to Raise and Lower Your Prices
4. Your sales staff relies on price cuts to close deals.
Are you becoming inundated with requests from your sales team to lower prices? This may mean your sales staff is not trained well enough to defend pricing and they're relying on discounts as a crutch to close a deal. But it can also signal a need to review your prices, not necessarily lowering them, but at least to consider a different pricing structure, says Per Sjofors, founder and CEO of Atenga Inc., a Woodland Hills, Calif.-based pricing-strategy consulting firm. Sjofors suggests a "good, better, best" strategy, where similar product is offered in three different options and price levels. "You may need to frame the 'better' offering to appear more affordable, even if it means having products in there that you don't really want to sell," he says. "But that makes the products you want to sell appear more reasonably priced."
5. Your business is attracting bargain hunters.
"We have a saying, 'You get what you price for,' " Sjofors says. For instance, if a hair salon prices a haircut at $8 or $12, it will most likely attract people who don't care about the quality of a haircut and who don't want to pay for extra services like a wash or blow dry. "Personal services are highly commoditized. You price low and what happens is you're going to attract the people willing to pay only the cheaper price," he says. In turn, your profit margins are going to be razor thin, which means you won't have the resources to innovate or market your products. In fact, Sjofors prefers to pay $24 for a haircut, even if he's not sure it's going to be better than the $12 job. "I simply would not trust someone cutting my hair for such a low price. I expect there to be something wrong with their hair-cutting skills when they sell their services so cheap...It is the price itself that makes the value."
Related: The Dark Side of Discounts