Pricing products and services

Tuesday 17 January, 2012

By Duncan - duncan@consumerchoices.co.uk

One of the biggest decisions a business has to make is how much to charge its customers. We highlight some of the key factors companies should consider when naming their price.

Just how much do you ask customers to pay for your product or service? It’s one of the most important business decisions you’ll make. It’s also one of the most daunting.

You can’t just pull a number out of the air - setting a price requires a great deal of thought and research. You must get it right, because if customers refuse to pay what you charge, it’s your business that will pay the price.

Things to consider first

There are a number of factors you must consider when setting prices. The three biggest are your costs, the value you offer customers, and your competition.

Costs

The cost of your product or service is the amount of money you spend to make or deliver it. Before you can turn a profit, you need to cover your costs, so it’s essential to know how much you spend.

Costs can be divided into two basic categories: fixed costs and variable costs. “Fixed costs” refers to the expenditure that’s ever -present your business, regardless of how much you sell. Examples of fixed costs include salaries, business rates and rent.

“Variable costs” change according to how the business is doing. If you’re selling more, you’re spending more on things like materials, travel and extra staff.

Value

The value of your business is what customers feel it’s worth to them. Sometimes the value of a product or service can be considerably more than the cost. For example, the cost for a plumber to come out and fix a leaky toilet might be £10 for travel, £3 worth of materials and an hour of labour - let’s say another £10. So that’s a cost of £23.

But for the customer, who has water sloshing all over the bathroom floor, and is lacking an essential amenity, the value is far greater than that. As a result, the plumber could charge £50. It’s considerably more than the cost, but the value to the customer justifies the price.

Competition

Before you set a price, you must know what your competitors are doing. A good way to do this is to check their website, or give them a quick phone call and ask for a quote. It’s important to look at what other firms in your sector are charging, before you set a price.

However, while undercutting your rivals can be beneficial, it’s certainly not essential. Remember, you need to cover your costs. If you can’t afford to compete on price, focus on delivering top-notch customer service, and justify your higher prices.

If you can afford to price your product or service less than rivals, be careful not to go too far below. Setting prices too low can be harmful, devaluing your product and your business. It’s often best to keep your prices comparable to your competition, so you’ve got some wiggle room to cut them further if other companies undercut you.

Setting your price

There are two basic methods of pricing: cost-plus pricing and value-based pricing. The one you should use depends on what your business does, and who your customers are.

Cost-plus pricing - what you charge is based largely on your business costs. When you set a price, you need to ensure it’s more than the variable cost of delivering the product or service. That way, each sale should go a little towards covering the fixed costs of business, and eventually making profit. The amount charged is usually a set percentage of a company’s fixed costs.

This type of pricing is most appropriate for businesses that deal with large volumes of products, or where the competition dominates on price. It’s a tried and tested method, albeit a narrow-focused one that doesn’t consider things like your brand image, or position in the market.

Value-based pricing - prices are set according to how much you think customers value what you offer. Rather than basing prices purely on cost (although costs must be covered), value-based pricing is about charging the most you think customers are willing to pay.

To determine your value, think about how customers make their buying decisions. A customer’s specific wants will vary depending on the product and industry, but common factors in their decision making process include the quality of the product or service, the speed of service, convenience, expertise and reliability. If you have clear strengths in any of these areas, you can charge more as a result.

Increasing or reducing prices

Prices can’t remain static forever. There will be times you need to alter what you charge, and it’s important to handle the change in the right way.

Raising prices

Increasing prices is often necessary - as your business grows, so will your costs, and variable market conditions mean you may have to pay more to your suppliers. Higher prices can increase profits, but you run the risk of losing customers. There are ways to minimise the impact, however.

The easiest way to keep customers onboard with the change is simply be honest with them. If prices go up, tell them why. If you treat them with respect and explain the situation clearly, many will understand. Of course, there will always be some dissenters, but even if they’re not happy you’ll find the majority of people are rational enough to accept it as a necessity.

You should also re-emphasise the benefits your business offers. Remind them that prices may be going up, but your company is still of value to them.

Reducing prices

Price cuts are sometimes the only way to keep pace with aggressive competitors. But lowering prices when you don’t really need to is a very brave move indeed. It’s also potentially foolish - people usually associate lower prices with lower quality. If you’re looking to increase sales, consider running promotions instead - a temporary discount, for example.

Resources

That’s just a basic overview of the minefield that is pricing. You can find more advice on the government’s Business Link website.

Photo by Banalities