Rachael Mockalis
For small business owners, the price-setting process seems daunting and complicated. You don’t want to go through the financial tribulations of trial-and-error, but setting your prices based on similar products is too impersonal to account for your business’s unique traits. Some might still be wondering, “What is the price-setting process?”
An Overview of the Process
Before diving into the particulars, let’s take a look at the overall process. Generally, there are six steps to deciding which price is right for you:
- Developing pricing objectives
- Assessing the target market’s evaluation of price
- Evaluating competitors’ prices
- Choosing a basis for pricing
- Selecting a pricing strategy
- Determining a specific price
For those just starting out, some of the terminology here might seem a little daunting, and that’s okay. Let’s look at the terms beginners might be a little less familiar with.
- Pricing Objectives are the starting goals and guiding principles your business sets to determine to price. Do you want to maximize profit, or retain customers? Are you more concerned with brand image, or beating out your competitors?
- The Market’s Evaluation of Price is understanding how much a customer is willing to spend on a product. How important is this product to your customers? What are their expectations of quality relative to price?
- A Basis for Pricing is the set of factors that determine your price floor. Oftentimes, this is the cost of producing the product you’re selling; you need to sell at a price higher than your costs to turn a profit.
- A Pricing Strategy is a plan for achieving pricing and marketing objectives.
Price-Setting Process Steps
Step 1: Developing Pricing Objectives
Remember that making a profit and keeping your business afloat are always implied objectives. So we’re going to talk about other pricing objectives—like maximizing profit, customer retention, and influencing brand image—and how to select them.
Factors to Consider
It’s important that your pricing objectives are specific to your business. Therefore, you’ll want to ask yourself about the following factors:
- Timing: Consider movie theater matinee times. People are less likely to see a movie during the day than at night, so movie tickets are cheaper during the afternoon to encourage people to buy tickets. There’s no need to provide that extra incentive at night, so they can focus on maximizing profit. Even if the time of day isn’t as important to your business, you’ll still need to consider seasonality, current events, and market trends to determine your prices.
- Market Position: Once your brand is well-established, higher prices may become more feasible. If you’re just starting out, lower prices may be more beneficial.
- Financial Circumstances: If your business is well-off, you may be able to prioritize marketing overturning profit. If not, then you need to focus on earning revenue.
- Broader Business Goals: What’s your business’ mission statement? Where do you see yourself a few years from now? How might your pricing affect these things?
Common Pricing Objectives
Once you take the above factors into account, you’ll want to choose your pricing objectives. Here are some common pricing objectives you might want to consider.
- Maximizing Profit: Though making a profit is always implied, many take it to its logical extreme. Maximizing profit is perhaps the most common pricing objective, based on raising profits and cutting costs whenever possible.
- Increasing Sales Volume: Meant to foster immediate, meaningful growth, this strategy is popular amongst businesses just getting started. The idea is to carve out a niche in the market by basing your pricing around it, and accommodating for shifts that could move you from that place.
- Shifting Brand Image: Ideal for luxury brands or value-oriented brands, this concept uses prices as a marketing tool. A designer boutique may use higher prices to create an air of prestige, while a family restaurant may use lower prices to foster the sense of getting a bang for your buck.
Step 2: Assessing the Target Market’s Evaluation of Price
Speaking of target audiences, the second step of price-setting involves evaluating what your target audience is willing to spend on your product. Take a look at the prices of similar products and services, if possible. If you create a unique product—such as artisan crafts or art—then you can still take a look at other artisan crafts or artwork.
You should also take a look at any gaps in the market. Let’s say you’re opening a family diner in a place with a lot of high-end restaurants and sports bars. If demographics show that a lot of families live nearby, then you’re filling a gap. This could affect how much your target values your restaurant.
You’ll want to find the “sweet spot” where you aren’t undervaluing your product, but you aren’t asking for more than the market’s willing to spend.
Step 3: Evaluating Competitors’ Prices
You probably won’t be the only family diner in town, however. This is why evaluating your competitors’ prices is also important. Even if your product is of much higher quality than your competitors, you don’t want to charge much more than them.
That being said, you don’t want to undercut their prices too harshly, either, because then you’ll start to eat into your own profit margins.
Step 4: Choosing a Basis for Pricing
Once you’ve evaluated your competitors’ prices, you can start looking for a basis for pricing. Three common bases are cost-based pricing, cost-plus/markup pricing, and demand-based pricing.
- Cost-Based Pricing: As previously discussed, one determinant for the price is the cost to make or provide the good or service you’re selling. Consider the costs of material, labor, overhead, and etc, then add a little more so you can turn a profit.
- Cost-Plus/Markup Pricing: This method is very similar to cost-based pricing, but with an extra step. Once you’ve calculated your price, you add a percentage of that price to the total. For example, if it costs $15 to make a good, and you’re going to use a 50% markup, you calculate $15 x 1.50 to get $22.50.
- Demand-Based Pricing: This pricing basis prioritizes flexibility and watching the market. When demand rises, your price rises. When demand drops, your price drops. This method can help minimize lost sales and lost revenue, but it can be somewhat difficult to manage without the help of software.
Step 5: Selecting a Pricing Strategy
Once you’ve considered your pricing basis, now you need to think about your pricing strategy. Here are some major pricing strategies to consider.
- New-Product Pricing: This strategy—as the name suggests—is employed when bringing a new product to market. Generally, businesses use one of two methods when employing this strategy:
- Price Skimming is charging the highest price buyers who most desire the product will pay.
- Penetration Pricing works by charging a very low price to “penetrate” the market and gain a foothold quickly.
- Differential Pricing: This strategy involves charging different people different prices for the same good or service. Allowing buyers to haggle, giving periodic discounts, and giving random discounts are examples of differential pricing.
- Promotional Pricing: When you employ this strategy, you’re framing your price as being a great value. Here are some ways you can accomplish this:
- Emphasize the fact your price is lower than similar products.
- Hold an advertised sale and/or cut prices around the holidays.
- Keep your prices below your competitors’.
These are far from the only pricing strategies, however, so it’s important to do your research and determine which strategy is best for you.
Step 6: Determining the Specific Price
Once you’ve completed the other five steps, you’re almost ready to set your price. You’ll want to make sure your pricing strategies are consistent with your market, or else you might find yourself out-paced.
When you’re sure you can keep up with your competitors, you can take all the information you’ve gathered in steps 1-5 and determine your pricing.
