How To: Set Prices Is the price right? 9 steps to pricing your product or service for maximum profits.

One of the earliest--and trickiest--decisions for new businessowners is determining what to charge for their products orservices. Some entrepreneurs use elaborate computations. Othersjust guess. But if you calculate or guess wrong, you'll soon beout of business.

"Setting prices is an art, not a science," says EdithQuick, partner with her husband, Roy, in Quick Tax & AccountingService in St. Louis. The art is in striking a balance between themoney you need to stay in business and the customer'sperception of what your product or service is worth.

Here are nine methods commonly used when setting or rethinkingyour prices. (Yes, rethinking. You should evaluate and adjust yourprices at least once a year to accommodate changes in competition,the economy, consumer tastes and your company's needs.)

1. Compare with the competition. Find out what productsand services similar to yours cost in your area, advises AndiAxman, coauthor with David H. Bangs Jr. of Launching YourHome-Based Business (Upstart Publishing, $22.95,800-245-2665).

"Prices vary from big cities like Boston or New York torural ones like mine," says Axman, who owns a marketingcommunications firm in Epsom, New Hampshire. If nearby competitorswon't reveal prices, try calling similar businesses in othercommunities similar to yours, she suggests.

Shahid Kinnare's Timezone store in Memphis, Tennessee, hasnumerous watch and jewelry retailer competitors nearby. "So Ilook at what services they don't have," Kinnare explains."I give free jewelry cleaning for a lifetime. I give alifetime guarantee on all my watches."

2. Check industry standards. Axman recommends askingtrade associations, chambers of commerce or other industry groupsfor pricing studies, surveys or related information. She also notesmany industries have helpful pricing books on the market. Forexample, desktop publishers can turn to Robert Brenner'sPricing Guide for Desktop Services (Brenner InformationGroup, $34.95, 800-811-4337).

3. Figure by formula. The owners of Huckleberry MountainCo., a Jackson Hole, Wyoming-based specialty manufacturer ofcandies and preserves, determine wholesale prices by multiplyingingredient costs by two, then adding 20 percent, says Judy Johnson,co-owner with her husband, Doug. The 20 percent covers distributionand sales commissions; the doubling of ingredient costs coverslabor and overhead.

Posh Impressions, which sells decorative rubber stamps andscrapbook supplies over the Internet and at retail stores in Irvineand Brea, California, sets its stamp prices at cost times two, saysco-owner Warren Gruenig.

Many entrepreneurs find such formulas easier than trying tofigure out all their costs or surveying their customers. However,use any formula with caution. It may not cover all your actualcosts--a quick path to financial disaster. Or you may cheatyourself out of some profits because customers may be willing topay more than the formula dictates.

No formula can substitute for the one number you must know: howmuch it costs to make a product or deliver a service. This is yourbreak-even point and your price floor.

4. Calculate backward. Some service providers andconsultants start with the annual income they want, then calculatebackward, says Roy Quick. If you work 40 hours a week all year andtake a two-week vacation, you'll put in 2,000 hours. However,service businesses can't bill for every hour. In the firstplace, it's virtually impossible to schedule clients for everysingle hour of every single day all year. Second, you must doadministrative tasks, marketing, bookkeeping and other duties forwhich you can't bill any customer.

The rule of thumb is that you will have 1,000 billable hours ayear. If you want to gross $50,000, you have to bill $50 an hour.If you want a $50,000 profit, you must carefully calculate yourcosts and add that amount into your hourly rate.

5. Add wiggle room. Roy Quick recommends serviceproviders add a little to their hourly rate "so you don'tnickel and dime your clients to death. If a client calls us with aquestion that takes five minutes, we don't charge for that, butwe do track those calls. Then if a client complains about the bill,we point out all the free services we gave all year."

6. Use "magic numbers." Psychology plays a rolein pricing, says Kinnare of Timezone. "I go for magic numbers.All my watches are $19.99. When I first started, I charged $20.99,but they didn't sell as well as [at] $19.99."

Many retail items are priced at a digit less than a roundnumber, such as $9.99 instead of $10 or $999 instead of $1,000,because the mind tends to perceive the difference as much greaterthan just a penny or a dollar.

7. Use introductory or limited-time pricing. Anotherquirk of the mind is that customers perceive your original pricesto be the correct value for your products or services. If you startlow and try to raise prices later, customers will balk. If youprice high at first, you can always reduce prices or add extraslater to attract more customers.

Homebased entrepreneurs sometimes run into customers who thinktheir prices should be cheaper because they don't paycommercial rents, Axman says. But homebased businesses still haveoverhead that must be included in their prices.

Besides, Edith Quick adds, if you lowball your prices, theneventually move into a commercial location, you'll have toraise prices--and that can drive away customers.

8. Charge what the market will bear. The prices youcalculate using formulas or adding up costs plus profit margin areyour ideal prices. "We have to balance our ideal with what themarket will pay," says candy-maker Johnson. "We do about40 trade shows a year and see what customers are paying. Ifwe're 40 percent higher [than the competition], then we'dbetter have something really special or drop our prices."

Just as your costs put a floor on your prices, consumers willestablish the ceiling. Do market research before investingthousands of dollars in mass production, distribution andadvertising. If you invent a product, make a prototype; then surveypotential customers about the price they would pay for theitem.

If your survey indicates people won't pay your break-evenprice, look at ways to cut your expenses. Or look for ways you canadd value, such as better performance, higher quality, fasterdelivery time--whatever will make the product or service worth morein the customer's mind.

If you can't make your product or deliver your service forless than customers will pay, you're not ready to go intobusiness.

9. Charge what you're worth. Many new business ownerssuffer from "lack of courage in pricing," says authorAxman. But underpricing can backfire, she adds, because if yourproduct or service is too cheap, clients may assume it's ofpoor quality.

Roy Quick agrees: "You have to bill at the rate you'reworth. We tell [service business] clients `If you're as busy asyou want to be, your prices need to go up.' Many start-upsaren't charging enough to succeed."

The art of pricing means achieving what you need by deliveringthe goods and services your customers want.

Add It Up

To price your product or service accurately, you must calculateyour costs. Here's how:

1. Add up all costs.Fixed costs are constantno matter how much or how little you sell; they include rent,property taxes, insurance, advertising, depreciation and intereston loans. Variable costs fluctuate based on the amount yousell; they include labor, sales commission, office supplies andsales tax. Semivariable costs include telephone, electricityand postage.

2. Determine your break-even point.
BP = VC + FC + SC (break-even point equals variable costs plusfixed costs plus semivariable costs)

Example: If variable costs = $1,000, fixed costs =$1,000, and semivariable costs = $1,000, then break-even point =$3,000.

3. Calculate your cost per unit (products) or per hour(services).
P = TC+M/N

Price equals total costs plus markup divided by number of unitsyou expect to sell or hours it will take to complete a project

Example 1: total costs = $3,000; markup = 50% ($1,500);number of units = 10,000; price per unit = 45 cents.

Example 2: total costs = $3,000; markup = 50% ($1,500);number of hours to complete a project = 50; price (hourly rate) =$90

(Note: If market research indicates consumers won't pay thisprice, you have to cut costs, and/or reduce your markup, and/orincrease the number of units you sell or reduce the time it takesto complete a project.)

Contact Sources

Andi Axman, (603) 736-8056, aaxman@aol.com

Huckleberry Mountain Co., P.O. Box 15270, Jackson Hole,WY 83002, fax: (307) 739-9355

Posh Impressions, (800) 421-POSH, http://www.poshimpressions.com

Quick Tax & Accounting Service, fax: (314)631-6722.