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There are a variety of different types of pricing strategies in

business. However, there's no one surefire, formula-based

approach that suits all types of products, businesses, or markets.

Pricing your product usually involves considering certain key

factors, including pinpointing your target customer, tracking

how much competitors are charging, and understanding the

relationship between quality and price. The good news is you

have a great deal of flexibility in how you set your prices. That's

also the bad news.

The following pages will detail how to meet your business goals

in pricing products, what factors to consider when pricing, and

how to determine whether or raise or lower your prices.

Dig Deeper: How to Profit from Market Research

How to Price Your Products: Meeting Business Goals

Get Clear about Making Money

The first step is to get real clear about what you want to achieve

with your pricing strategy: You want to make money. That's why

you own a business. Making money means generating enough

revenue from selling your products so that you can not only

cover your costs, but take a profit and perhaps expand your

business.

The biggest mistake many businesses make is to believe that

price alone drives sales. Your ability to sell is what drives sales

and that means hiring the right sales people and adopting the

right sales strategy. "The first thing you have to understand is the

selling price is a function of your ability to sell and nothing else,"

says Lawrence L. Steinmetz, co-author of How to Sell at Margins
Higher Than Your Competitors : Winning Every Sale at Full Price,

Rate, or Fee (Wiley 2005) and a business consultant in Boulder,

Colo. for 40 years. "What's the difference between an $8,000

Rolex and a $40 Seiko watch? The Seiko is a better time piece. It's
far more accurate"¦. The difference is your ability to sell."

At the same time, be aware of the risks that accompany making

poor pricing decisions. There are two main pitfalls you can

encounter - under pricing and over pricing.

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Under pricing. Pricing your products for too low a cost
can have a disastrous impact on your bottom line, even

though business owners often believe this is what they

ought to do in a down economy. "Accurately pricing

your product is critical at any point in the economic

cycle but no more so than in a recession," says Laura
Willett, a small business consultant and faculty member

in the finance department at Bentley College in

Waltham, Mass. "Many businesses mistakenly under
price their products attempting to convince the

consumer that their product is the least expensive

alternative hoping to drive up volume; but more often

than not it is simply perceived as 'cheap." Remember

that consumers want to feel that they are getting their
"moneys worth" and most are unwilling to purchase

from a seller they believe to have less value, Willett says.

Businesses also need to be very careful that they are fully

covering their costs when pricing products. "Reducing

prices to the point where you are giving away the
product will not be in the firm's best interest long

term," Willett says.

Over pricing. On the flip side, overpricing a product can
be just as detrimental since the buyer is always going to

be looking at your competitors pricing, Willett says.

Pricing beyond the customer's desire to pay can also

decrease sales. Toftoy says one pitfall is that business

people will be tempted to price too high right out of the
gate. "They think that they have to cover all the expenses

of people who work for them, the lease, etc. and this is
:
what price it takes to do all that," he says. "Put yourself

in the customer's shoes. What would be a fair price to

you?" He advises taking little surveys of customers with
two or three questions on an index-card-sized form,

asking them whether the pricing was fair.

Understand Your Other Business Priorities

There are other reasons to go into business. Understand what

you want out of your business when pricing your products. Aside
from maximizing profits, it may be important for you to
maximize market share with your product -- that may help you

decrease your costs or it may result in what economists call

"network effects," i.e. the value of your product increases as

more people use it. (A great example of a product having

network effect is Microsoft's Windows operating system. When
more people began to use Windows over rival products, more

software developers made applications to run on that platform.)

You may also want your product to be known for its quality,

rather than just being the cheapest on the market. If so, you may
want to price your product higher to reflect the quality. During a

downturn, you may have other business priorities, such as sheer

survival, so you may want to price your products to recoup
enough to keep your company in business.

Dig Deeper: How to Price Business Services

How to Price Your Products: Factors to Consider

"There are many methods available to determine the 'right'

price," Willett says. "But successful firms use a combination of

tools and know that the key factor to consider is always your
customer first. The more you know about your customer, the

better you'll be able to provide what they value and the more
you'll be able to charge."
:
Know Your Customer

Undertaking some sort of market research is essential to getting

to know your customer, Willett says. This type of research can

range from informal surveys of your existing customer base that

you send out in e-mail along with promotions to the more
extensive and potentially expensive research projects undertaken

by third party consulting firms. Market research firms can

explore your market and segment your potential customers very
granularly -- by demographics, by what they buy, by whether they

are price sensitive, etc.. If you don't have a few thousand dollars
to spend on market research, you might just look at consumers

in terms of a few distinct groups -- the budget sensitive, the

convenience centered, and those for whom status makes a
difference. Then figure out which segment you're targeting and

price accordingly.

Know Your Costs

A fundamental tenet of pricing is that you need to cover your
costs and then factor in a profit. That means you have to know

how much your product costs. You also have to understand how
much you need to mark up the product and how many you need
to sell to turn a profit. Remember that the cost of a product is

more than the literal cost of the item; it also includes overhead
costs. Overhead costs may include fixed costs like rent and
variable costs like shipping or stocking fees. You must include

these costs in your estimate of the real cost of your product.

"Come up with X first. X is your cost of raw materials, labor, rent,

and everything it took to make the product so that if you sold it
you would break even," advises Toftoy. "Y becomes what you
think you need to make on it. That may depend on your

business. Restaurants overall make about 4 percent, which is

pretty low. If you want 10 percent then you factor that into your
costs and that is what you charge."
:
Many businesses either don't factor in all their costs and under
price or literally factor in all their costs and expect to make a
profit with one product and therefore overcharge. A good rule of
thumb is to make a spread sheet of all the costs you need to cover

every month, which might include the following:

Your actual product costs, including labor and the costs

of marketing and selling those products.
All of the operating expenses necessary to own and

operate the business.

The costs associated with borrowing money (debt service
costs).
Your salary as the owner and/or manager of the business.
A return on the capital you and any other owners or

shareholders have invested.

Capital for future expansion and replacement of fixed
assets as they age.

List the dollar amount for each on your spreadsheet. The total
should give you a good idea of the gross revenues you will need
to generate to ensure you cover all those costs.

Know Your Revenue Target

You should also have a revenue target for how much of a profit
you want your business to make. Take that revenue target, factor
in your costs for producing, marketing, and selling your product

and you can come up with a price per product that you want to
charge. If you only have one product, this is a simple process.
Estimate the number of units of that product you expect to sell
over the next year. Then divide your revenue target by the
number of units you expect to sell and you have the price at

which you need to sell your product in order to achieve your

revenue and profit goals.

If you have a number of different products, you need to allocate

your overall revenue target by each product. Then do the same
:
calculation to arrive at the price at which you need to sell each
product in order to achieve your financial goals.

Know Your Competition

It's also helpful to look at the competition -- after all, your
customer most likely will, too. "Are the products offered
comparable to yours? If so, you can use their pricing as an initial
gauge," Willett suggests. "Then, look to see whether there is
additional value in your product; do you, for example offer

additional service with your product or is your good of perceived

higher quality? If so, you may be able to support a higher price.
Be cautious about regional differences and always consider your
costs."

It may even be worthwhile to prepare a head-to-head

comparison of the price of your product(s) to your competitor's
product(s). The key here is to compare net prices, not just the list
(or published) price. This information could come from phone
calls, secret shopping, published data, etc. Make notes during this

process about how your company and products -- and the

competition -- are perceived by the market. Be brutally honest in
your evaluation.

Know Where the Market Is Headed

Clearly you can't be a soothsayer, but you can keep track of

outside factors that will impact the demand for your product in
the future. These factors can range from something as simple as
long-term weather patterns to laws that may impact future sales
of your products. Also take into account your competitors and

their actions. Will a competitor respond to your introduction of

a new product on the market by engaging your business in a
price war?

Dig Deeper: When Customers Grumble about Price Hikes

How to Price Your Products: Deciding to Raise or Lower

:
Prices

One size does not fit all. You can only go so far pricing all your

products based on a fixed markup from cost. Your product price

should vary depending on a number of factors including:

What the market is willing to pay.

How your company and product are perceived in the

market.
What your competitors charge.
Whether the product is "highly visible" and frequently
shopped and compared.
The estimated volume of product you can sell.

That opens the door to raising and/or lowering prices for your
products. In order to make this call one way or the other, you
should first understand what's already working. Analyze the
profitability of your existing products, so you can do more of
what works and stop doing what doesn't work. You want to find

out which of your existing products are making money and

which are losing money. You may be surprised at how many of
your products are losing money -- fix those ASAP.

You should also constantly re-evaluate your costs. To sell it right,

you have to buy it right. If you are having a hard time selling a

product at an acceptable profit, the problem may be that you are

not buying the product right. It may be that your cost is too high
rather than your price is too low.

When to Raise Prices -- and How

You should always be testing new prices, new offers, and new
combinations of benefits and premiums to help you sell more of
your product at a better price. Test new offers each month. Raise
the price and offer a new and unique bonus or special service for
the customer. Measure the increase or decrease in the volume of

the product you sell and the total gross profit dollars you
:
generate.

It is a fact of life in business that you will have to raise prices

from time to time as part of managing your business prudently.
If you never raise your prices, you won't be in business for long.
You have to constantly monitor your price and your cost so that
you are both competitive in the market and you make the kind

of money you deserve to make.

"The best way to determine if the product is being priced

correctly is to watch sales volumes immediately after making any
change," Willett says. "This can be done by watching cash
collections (if the business is cash or credit card based) or credit

sales (if accounts receivables are used) for the weeks following. If
a price increase is too high, customers will react pretty quickly.
Also watching the competition can help - if you've made a
positive change in prices; competitors are likely to follow suit."

But there is a right way and a wrong way to raise prices. You
don't want to alienate your existing customer base by raising
prices too steeply, especially during a recession. "Rather than
have a sudden increase, have a strategic plan over two to five
years during which you gradually increase your price 5 to 10

percent," Toftoy advices. "If the business is in trouble and you

say, 'Hey, I'm going to mark everything up"¦ that kind of scares
people away. This way you haven't gone from $5 to $15. You've
gone to $7.50 first."

"In terms of raising the price -- this is more easily accepted in

'good' economic times," Willett says. "As the underlying cost of
producing the product rises, the customer is prepared to accept
the rise in the price to them. If the customer perceives that the
firm's costs are going down while their price is going up. This will

not be received well and is likely to backfire."

:
When to Lower Prices -- and How
You may realize that you have missed your target audience by

pricing your products too high. You can always choose to

discount your products or give customers something for free in
order to get them to try your product or generate traffic to your
storefront or website. "You have to get people in," Toftoy says.
"People like getting something for free or some kind of discount.

You can make Wednesday senior citizen day when seniors get a
20 percent discount. Then maybe you can offer a student
discount day. Then all you're doing is keeping the price the same,
but to those people you're giving them a cut but it's not like
you've lowered all prices."

Generally, lowering prices is not a good practice unless you are

using this strategically to garner market share and have a price
sensitive product or if all of your competitors are lowering their
prices, Willett says. "An alternative to lowering price is to offer

less for the same price which will effectively reduce your costs
without appearing to reduce the value to the customer," she says.
"Restaurants have found this particularly helpful in terms of
portion sizes but this same strategy can be applied to service
industries as well."

Monitor Your Pricing

Another key component to pricing your product right is to
continuously monitor your prices and your underlying
profitability on a monthly basis. It's not enough to look at
overall profitability of your company every month. You have to

focus on the profitability (or lack of profitability) of every

product you sell. You have to make absolutely sure you know the
degree to which every product you sell is contributing to your
goal of making money each month. Remember: "People respect
what you inspect."

Here are some other practices to help you price right:

:
Listen to your customers. Try to do this on a regular

basis by getting feedback from customers about your

pricing. Let them know you care about what they think.
Keep an eye on your competitors. If you don't have
deep pockets and can't afford to hire a market research
team, hire some college students to go out on a regular

basis and monitor what your competitors are doing.

Have a budget action plan in place. Try to have a plan
for your pricing that extends out three to six months in
the future.

You owe it to yourself and to your business to be relentless in

managing your product pricing. Remember, how you set the

price of the products could be the difference between the success

-- or failure -- of your business.

Dig Deeper: Making the Case for Higher Prices

Related Links:
Case Study: Finding the Right Price for a Hot Product

Luke Skurman's quirky college guides were a big hit. The

problem was getting readers to pay. What if he gave the content

away?

Recession Pricing Strategies: How Low Can You Really Go?

Tempted to cut prices? You're not alone.

The Price Is Right

Setting prices has always been more art than science. New
software aims to change that.

The Right Price

Too many new entrepreneurs harm their own prospects by

under pricing their goods and services. But if those company

owners just take the time to think, they can set their prices closer

to fair market value.

:
Is It Time to Raise Prices?
Boost your bottom line by taking the guesswork out of pricing.

Flexing Your Pricing Muscles

Despite years of almost no inflation, you may have more pricing

power than you think. Here's how to exercise it without bruising

yourself in the process.

Recommended Resources:
The Art of Pricing: How to Find Hidden Profits to Grow Your Business

By Rafi Mohammed
www.rafimo.com

The author has a very interesting point about how to get out of

the pricing "Catch 22" by adopting a multi-price mindset.

How to Sell at Margins Higher than Your Competitors: Winning Every

Sale at Full Price

by Lawrence L. Steinmetz, and William T. Brooks

National Federation of Independent Business

This trade association for small and mid-sized businesses

maintains a section on how to set prices, when to give discounts,

and when to raise your rates, among other topics.

U.S. Small Business Administration

Government agency for small business matters operates a

website devoted to market and price decisions that businesses

must make.

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