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Name Your Price

Stumped about what to charge? Setting prices is both an art and a science--and a little bit of guesswork. Here's how to figure it out.

This story appears in the September 2005 issue of Entrepreneur. Subscribe »

Jeannette Doellgast spends a lot of time thinking about numbers. She has been doing so for more than a year, ever since she and her husband and business partner, Mohsen Alam El Din, bought the Plumbush Inn in breathtakingly scenic Cold Spring, New York. For Alam El Din, 50, born in Egypt and entrenched for 20 years in the restaurant industry, running his own company is his American Dream. Doellgast, 44, gamely switched careers to join him-after about 15 years as an executive in the textiles industry, and a three-year stint as an elementary school teacher. With the bed-and-breakfast, she soon found herself immersed in the art and science of setting prices.

First, Doellgast concluded that they would have to raise all the prices for both the rooms and food at the Plumbush Inn, which had been in existence for 30 years when the couple bought it. Long-time customers weren't pleased, and they made sure to let Doellgast and Alam El Din know it. "It was a risk," admits Doellgast.

It has paid off. The Plumbush Inn stands to bring in $1.25 million by the end of 2005. Considering that Doellgast and Alam El Din paid $1 million for the business-with a matrix of many loans and all their life savings-they appear to be off to a good start.

As you likely know or suspect, you'll have many motives when deciding the prices for your products and services, from understanding what the market can bear to figuring out what you can bear. It may be that you want to serve customers with modest incomes, or perhaps you aspire to a level of greatness that demands high prices. As Doellgast herself observes, "It's instinctive and emotional, but part of it is also tangible." In elaborating on that point, she adds: "Oil bills go up every year, electric bills. Expenses are continually rising."

Watching inflation reports and making sense of what's going on in the market can make new entrepreneurs wonder what they should charge for their products and services. And you should wonder. If you don't, and you come up with your fees lightly, you yourself may end up paying the hefty price.

Determining the Price

There is no set formula for price-making, because every single business is unique. If setting prices were simple, there wouldn't be a Professional Pricing Society in Marietta, Georgia, a support group full of people whose job it is to determine prices. But at its most basic level, you could think of it in the way that Gaithersburg, Maryland, business strategy consultant Marsha Lindquist does.

"I can get fancy," says Lindquist breezily. "But the basic questions you need to answer are, What is the market going to pay, and what are your costs?"

Those two concepts get a little tricky when you're a service business and not selling a product, so let's stay with products for a moment: Meet Anthony Shurman, 34, president of Yosha Enterprises Inc. in Westfield, New Jersey. His company provides a valuable service to the world-conquering bad breath. His product is Momints, breath mints that were introduced in 2002 at $1.99 for a 36-mint package. Later, Shurman dropped the price to $1.79, and in 2003, he took the product nationwide, charging $1.69 per package. Each time he dropped the price, he had a good reason for doing so-to stay competitive with competing brands.

When Momints debuted, Shurman says it was the only liquid breath mint on the market, so its uniqueness allowed him to charge higher prices. As Shurman explains, "I think when you're launching a new product or starting a new business, there are plenty of examples of businesses going after a target audience and creating a cachet for themselves by pricing a little higher and adopting an elite strategy, where you present yourself as this high-end competitor in the market." Shurman also felt he could price the product a little higher because each package had 36 mints, more mints than any other brand.

Looking back, Shurman believes his first strategy for pricing really wasn't the best one. "If I were to do it again, I probably would have started with a lower price. Our consumers don't really give us credit for having those extra mints, and I think a more visible difference to the average consumer would be a lower price," says Shurman. That's why he recently used a regional grocery chain as a test market, where he sold a 28-mint package for 99 cents-70 cents less than his 36-mint package. Says Shurman, "Our sales went up 350 percent." Yosha now brings in more than $3 million annually, and Shurman has reason to believe he'll sell even more mints at the lower price.

Shurman's story can't help but reinforce the idea that coming up with the right price is vital. "If you're off [from what the consumer wants to pay] by a few pennies here and there, it probably doesn't matter much," concedes Shurman. "But I do think it's a critical part of the overall package. If you're going to price a product at $5, when it should have been $1.99, that could spell doom."

However, while understanding what the customer is willing to pay is important, so is understanding your own psychology when it comes to money. After all, the price you select for a product or service is going to reflect on both you and your business. Is your company one that attracts those who identify with Desperate Housewives, or the desperate housewives clipping coupons and wondering if their husbands are going to be laid off? There's no right answer. Both markets need to be served. But if you figure out who you are and what you want your company to be, you'll better understand who your customer is.

Who Are You?

Doellgast asked herself that question during the two months she and her husband searched for loans and considered buying the Plumbush Inn. "You have to dedicate some serious time to looking at everything, going out and collecting all the information," says Doellgast, who diligently examined the pricing on their competitors' menus. "Then you put it on paper, and you need to seriously study it. It needs to be a serious time without distractions, where you ask and answer the questions, Who am I? [What] do I want our business to be?"

Doellgast and her husband decided they wanted it to be upscale, the kind of B&B where romantic couples go, not the kind of place where a family of eight might stop in for cheap lodging for the evening. "We are a slow-dining experience," says Doellgast, who says she raised the prices because offering the public a richer experience costs more money. Says Doellgast, "We don't buy anything frozen. Everything is fresh, which makes a difference in the price."

The Plumbush Inn also uses organic products, which cost more. But when people know what they're getting, they don't mind paying for it. In fact, Doellgast points out that the customers who had initially been angry at them for raising rates later returned with new expectations-realizing they were coming to a high-end inn-and seemed very happy with the changes (see "Dollar Signs".)

"People bring a whole set of equations with them when they make a purchase, and one of the values for most people is that high price equals quality," says Rob G. Docters, co-author of Winning the Profit Game: Smarter Pricing, Smarter Branding. "If you're successful, you ought to have a price that reflects the success."

In the same breath, Docters warns not to go overboard: "Customers resent it when they think you're charging them much more than you should be. It's an old Puritan ethic--nobody wants to be ripped off. So you have to know your customers and what they will tolerate."

The Intangibles

If you're selling breath mints, there are a lot of fixed costs that go into creating your product and distributing it, and of course, the store selling your product deserves a cut, too. Even your customers understand that you incur those costs and that you deserve a profit.

It's a little different selling yourself, as 35-year-old Joshua Estrin discovered after forming Concepts in Success, a business development firm in Fort Lauderdale, Florida, in 2001. After years in the nonprofit sector, Estrin formed a company that helps businesses and nonprofits with everything from business planning to event planning. His business's goal is, in a few words, to help companies grow.

It's a lofty but nebulous goal, and when Estrin tried to determine the price for his services, he came up with a yearly salary and tried to work out a formula in which every project would pay him as much as if he were working for the company full time. "That was a lesson learned," says Estrin. "I spent a whole heck of a lot of energy documenting every last breath, phone call and hangnail to my clients."

Later, Estrin switched to an hourly rate-which exceeded $100 an hour-and found he could live with that. Eventually, he decided to switch to price points-set fees he could charge for the various services he offers companies. It's a strategy that still seems to be working four years later. Concepts in Success, which has only one full-time employee besides Estrin and about 15 to 20 contract workers, should bring in approximately $1 million in sales by the end of the year, and its clients have included American Airlines, American Express, Hertz and Pepsi.

"In the beginning, I struggled, but I made the decision to stay true to my gut," says Estrin of coming up with those initial fees, which were often in the thousands of dollars. "In those first few test runs, I'd go out and network, have people ask what my rate was, watch them usually catch their breath and fall out of their chairs, and practice not apologizing for it."

And if you have a strong background in the area you're consulting in, you shouldn't apologize. Remember that when someone pays you for an hour of consulting work, the fee covers more than just your time; it includes the experience through which you built your expertise. It's similar to paying for a surgical procedure-the cost includes not only the time the surgeon spends operating, but also the body of knowledge underlying his or her ability.

It's also a smart idea to try and turn an intangible into something you can touch. "In my business, financial consulting, we'll bring out mock financial plans and show them to clients or prospects so they can see exactly what they're going to get," says Los Angeles business advisor Robert Pagliarini. "Suddenly, you've turned a service into a product. We can show them sample reports, charts and graphs-all these products that really represent the service we provide."

A shrewd strategy, because adding value to your price is what really wins over consumers. "Pricing is not about cost, it's about value," says Docters. "Because the fact is, it doesn't cost Chevrolet twice as much to manufacture their cars. They can charge as much as they do because it's about value instead of cost."

"Pricing is an art, but it's not only about pricing, it's about differentiating yourself and deciding what your niche [is], and what the value of your niche [is]," says Doellgast. "If you only build your [business] around your low price, somebody else is going to come along next week and undercut you. And then how have you established your market? You really haven't."

Golden Rules of Pricing

Setting a price is dizzying to think about, isn't it? If you're truly overwhelmed and don't have the time to take a pricing class from Dilip Soman, marketing professor at the University of Toronto, check out these five basic rules he gave us, distilled from one of his lectures:

1. Never set your price lower than what it costs to stay in business. Sounds obvious, but you'd better remember it.

2. Bigger objects are always more valued than smaller objects. That's probably why, says Soman, software manufacturers package small disks in large boxes.

3. It's always easier to substantially increase your prices when you have fewer competitors (think airline seats) than if you have a lot of competitors (think gasoline stations).

4. If you own a service business and you want to charge high prices, don't be afraid to start on the low end of the scale and raise your prices later. It's easier if you develop a reputation for good service first.

5. If you have to increase your prices shortly after starting up your business, consider offering something that will make the product or service more valuable-like changing the packaging of your product or adding more support to your service.

Geoff Williams admits that when it comes to paying for anything, his favorite price is cheap.

Written By

Geoff Williams has written for numerous publications, including Entrepreneur, Consumer Reports, LIFE and Entertainment Weekly. He also is the author of Living Well with Bad Credit.