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Four Rules for Pricing Products Before you put a price tag on a product or service, find out how much customers value it.

By Mark Stiving Edited by Dan Bova

Opinions expressed by Entrepreneur contributors are their own.

Four Rules for Pricing ProductsBefore pricing your products and services, you need to understand how customers perceive value. I continually find business owners price their products or services based on what they cost, versus what their customers are willing to pay.

Even worse, I find businesses that base prices simply on what their competitors are able to get away with. A bicycle shop will mark up the price of its bikes 20 percentage points because that's what the shop on the other side town does. Same goes for the 30 points on bike parts and the 50 points on bicycling clothes.

Related: Why You Don't Want to Be the Low-Cost Leader

In both cases, these businesses are failing to put real thought into their pricing, and I guarantee they are missing out on profits and are putting themselves at risk of losing out on potential customers because they aren't charging what those customers are willing to pay.

Contrast that with Brooks Brothers, where a suit might easily run $150 more than a suit at Men's Wearhouse. But that's because Brooks Brothers officials know that their customers place a higher value on their store chain's label, its panache. The people who aren't willing to spend the extra $150 aren't the type of customers Brooks Brothers wants anyway.

That's what smart pricing is all about: Know who your competitors are and what they charge, measure what makes your products or services better or worse, and then add and subtract accordingly from your competitors' prices to figure out your own.

It's a pretty simple formula, but the devil is in the details. Here are some things to keep in mind as you crunch the numbers:

1. Listen to your customers. You really don't need to hire a marketing research firm to understand how your customers value your products versus competitors. Just take some time to ask customers questions and actually listen, versus just trying to close a sale. This is a good sales technique anyway.

Related: Small Business Lessons from Netflix's Pricing Debacle

2. Know your competition. This can be an awkward question to ask a customer, but it is worthwhile to ask, "If you weren't doing business with me, who would you go to?" How is the competition different, and how do your customers value what is different? Prepare yourself for surprises when you start finding out your real competitors, and the benefits the competition may have over you. You're learning stuff you didn't know.

3. Be honest and fair in your self-evaluation. Brutal honesty -- it's very hard for people to do. I typically find that business owners and executives will overvalue the positive aspects of their business, and ignore the advantages their competitors have over them. Going back to the bicycle shop example, the owner might highly value that the store carries Continental tires -- simply because one customer a month ago was happy they were in stock. At the same time, the competitor across town has a bike wizard handling repairs, something customers are willing to pay extra for. Simply charging what the competitor charges is going to miss the mark.

4. Recognize that customers are different from others. Some people value a neighborhood bike shop, while others might have no problem taking a bike off the rack at Walmart. What you charge becomes a question of who you really want to compete with and what type of customers you want to attract. The smart move is set your prices for a particular group of potential customers, rather than all of them.

Related: Five Signs It's Time to Change Your Prices

Mark Stiving

Speaker, writer, coach and consultant

Mark Stiving, PhD, MBA, is a recognized pricing expert with has more than 20 years' experience in helping businesses boost revenue and profit. He is also an instructor at Pragmatic Marketing. Mark is the author of Impact Pricing: Your Blueprint for Driving Profits, from Entrepreneur Press.

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