Pricing strategies for small businesses

Setting the most appropriate price for your products and services can be the difference between success and failure for your business. Set them too low and you could quickly encounter cash-flow problems, but set them too high and your potential customers may choose to look elsewhere.

Daryl Johnson heads NAB’s nabbusiness division. He says there are a number of factors small businesses need to consider when it comes to setting price.

“First of all ask how important price is to the marketing of your business; will price influence your customers,” he says. “While luxury brands constrain volume and keep prices high customers expect this but at the other end if you want to sell millions of products you might keep your margins skinny and your prices low.”

He says you should also understand who are your target customers and what is their capacity to pay.

“Another point that is sometimes forgotten is knowing what it is costing you to manufacture or to buy the raw product so you can understand your cost base,” he says. “Work out which costs are fixed and which are variable and dependent on sales. One of the challenges is that if a high proportion of your costs are fixed and your sales fall then you may not be able to get your prices down quickly enough to counteract the effect on your business.”

Dun & Bradstreet marketing director Danielle Woods says it is essential to understand the market a business operates in before any pricing decisions are made. “Conduct some market research to determine who your competitors are and how much they are charging,” Woods says. “It is worth checking out their websites or going into their stores, if they have a physical location, to find out how your product compares to theirs. It will also give you insight into what the key features and benefits of their products are, and if they can be differentiated from yours.”

There are two main methods of setting prices: the cost-based or cost-plus pricing method and the value-driven method. The cost-driven strategy is derived from how much profit a business wants to make. Woods says this involves adding on an amount you need to make a profit onto your production costs.

“For example, if you want to make a 20 per cent gross profit margin on your $100 product, you will charge $120,” Woods says. “This method is effective because it tells you if your prices are reasonable. If your prices are less than your direct costs, you will make a loss. If your prices are higher than your direct costs, the money you make will go towards covering your fixed or overhead costs.”

The value-driven method, however, refers to setting prices based on what the consumer is likely to pay, and on the “value” of the product or service. Woods says for example, if you own a cafe, it is reasonable to charge $3 to $4 for a regular sized cup.

“However, if you want to charge more for a cup to raise your profits, you will need to convince the customer why they should pay more,” Woods says. “This usually involves a significant amount of marketing or publicity, which most small businesses do not have the resources to undertake.”

Woods adds that the reason why companies such as Starbucks can charge more for a cup is because customers perceive the coffee chain as “branded” and “luxury”. “Unless your business offers a niche or unique product, you will be better off setting your price point at the market standard,” Woods says. “Once demand picks up, you may be able to increase your prices.”

Johnson says don’t forget that not everything is about price. He cites businesses he knows of in similar industries where some have price conscious customers and others don’t.

“We found that the ones where the customers are less price-conscious are the ones who have added value in some way,” he says. “We find that if businesses deliver well and have some sort of extra value add that could be intangible – perhaps the service – then customers are less worried about the price.”

One factor that is critical for businesses to understand is the impact of pricing decisions on cash flow. He often sees the effects of changes to prices flow through to volume. “They can be positive or negative but before decisions are made businesses need to know the price-volume tradeoff. Their pricing approach needs to be integrated into their financial models so they properly understand the consequences of any pricing decision.”


The original release of this article first appeared on the website of Hangzhou Night Net.