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What Should You Charge?

You need to charge enough to cover costs, but keep prices low to attract customers. Here's how to balance that equation.
December 11, 2003
URL: http://www.entrepreneur.com/article/66026

The prices you charge for what you sell have an enormous ability to affect your company's growth. They can lure some customers and drive others away, produce profits from declining products and turn cash cows into money-losing dogs. These results can be produced by either lowering or raising prices. Results depend not on whether your prices increase or fall, but on your market, your product, your competition, your goals, and the precise mechanism you employ to adjust prices.

Prices fluctuate constantly for some things, such as food and gasoline, and remain about the same for others over years or even decades. Some products seem to have rapidly changing prices, but in reality the prices don't change much-it's the products that change. For example, look at personal computers. The price for a midrange personal computer has been about $2,000 for many years, despite the fact that the computer you paid $2,000 for last year can now be bought for less than half that.

Whether you are in an industry with rapidly changing prices or pricing that seems set in concrete, it's a good idea to evaluate your pricing periodically to see if you could generate some growth by tinkering with it. There are several ways to decide what your prices should be. They include matching the competition, charging whatever the market will bear, and marking up from your own costs.

Competitive pricing seeks to match what others charge for the same product or service. All pricing has to take competitors into account. When you are a small company in a large market, you will almost be forced to follow others' lead on pricing. That means pricing your product neither very far above or below what others charge. As you grow larger, you will be able to exert more independence in pricing, especially if you can differentiate your offering as exceptionally high in value. You can take the lead in pricing, forcing others to match your low prices, when you gain enough experience and volume to truly become the low-cost producer.

Using the cost-based pricing technique, you calculate what it costs to produce your goods or services-including such items as salaries and benefits, materials and supplies, and sales and overhead-and then add whatever amount you think is appropriate for your gross profit margin. Some businesses, such as those that perform repairs, have prices explicitly based on adding a preset profit margin to whatever it costs to do the job. However, customers are generally not concerned about what it costs you to provide a good or a service. So while cost have to be a consideration in your pricing, your costs are rarely justification for higher prices in the marketplace.

The main thing you should be concerned about with pricing is neither what others are charging nor what it costs you to compete. It is maintaining a proper balance of supply and demand. Simply put, if you have more business than you can handle, raise prices. If you are sitting around with nothing to do, reduce prices. If competitors follow suit, you may have to discount again until you capture enough business to sustain your operation. If you can't reduce prices enough to make money, you will have to cut costs somehow.

Various tactics can be used within these strategies. Skimming is the practice of charging high prices, usually for new products, to take advantage of the willingness of early adopters to pay more. Skimming can allow you to recoup development costs of new products and services. Buying market share is what companies call it when they charge initially low prices with the intent of getting people to try their product and, hopefully, like it enough to pay more for it later on.

Managing the competing interests of supply, demand, cost and competition is a lot to ask. But pricing is up to the challenge. Finding the sweet spot between your cost and the highest price customers will tolerate, given existing competition, requires near-constant tinkering with prices, observation of the results, and frequent analysis of what you could do better.

Excerpted from Growing Your Business