Pricing is a procedure to determine how much the company will receive in exchange for its specific product or service. Intelligent and correct pricing is one of the most important elements of any successful business venture.
If your price is too high demand will reduce and you may price yourself out of the market. If the price is set too low, your sales volume may not generate enough revenue to cover the costs associated with your business. So the price of the product must cover costs and profits.
In starting a business, regardless of whether it’s small or large, you must carefully consider your pricing strategy before you start. Established businesses can improve their profitability through regular pricing reviews. The most important thing about pricing is to know the product’s cost price.
- The cost of your product or service is the amount you spend to produce it
- The price is your financial reward for providing the product or service
- The value is what your customer believes the product or service is worth to them
Different Cost Factors in Pricing
You will need to calculate first the cost price of your product to make a profit. Working out the accurate cost price of your product is the most essential part of pricing. Generally, every cost can be divided under these two terms. One is the fixed cost and another is the variable cost.
Fixed costs are expenses that have to be paid by a company, independent of any business activity. Such as rent, leases, salaries, etc. variable costs are those that rise as your sales increase, such as additional raw materials, extra labor, utilities, transport, etc.
Different Pricing Strategies in Business
1. Cost-Plus Pricing
Cost-plus pricing is a very popular method in the manufacturing industry. Under this approach, you add together the direct material cost, direct labor cost, and overhead costs for a product, and add to it a markup percentage (to create a profit margin) in order to derive the price of the product.
Cost of Materials + Labour Cost + Overhead cost = Total Cost + Desired profit (30%) = Product sell price.
It is quite an easy process of product pricing, though you should define the overhead allocation method in order to be consistent in calculating the prices of multiple products.
2. Value-Based Pricing
This focuses on the price you believe customers are willing to pay, based on the benefits your business offers them. Value-based pricing depends on the strength of the benefits you can prove you offer to customers.
You will need to know your market well to set a value-based price. By contrast, cost-plus pricing is based on the amount of money it takes to produce the product. Furthermore, companies that offer unique or highly valuable features or services can take advantage of value-based pricing.
3. Demand Pricing
Demand pricing is generally fixed by the optimum combination of volume and profit. Products generally sold through channels at different prices–retailers, discount chains, wholesalers, dealers; are examples of goods whose price is determined by demand.
When a wholesaler or distributor buys the product in large quantities, he/she gets it at a lower unit price. But when a retailer pays more per unit quantity as he/she is purchasing in small quantities.
4. Competitive Pricing
Setting the price of a product or service based on what the competition is charging. A competitive pricing strategy is used more often by businesses selling similar products since services can vary from business to business while the attributes of a product remain similar.
To use competitive pricing effectively, know the prices each competitor has already established. You can go in three ways below the competition, at the competition, or above the competition.
5. Markup Pricing
Mark up refers to the value that manufacturers, wholesalers, and retailers add to the cost price of a product. The value added is called the mark-up. The amount to be marked up is decided at the discretion of the company.
Basically, this approach sets prices that cover the cost of production and provide enough profit margin to the firm to earn its target rate of return.
6. Skimming Pricing
If you have a unique product or service, you can sell it at a high price. This is known as skimming – but you need to be sure that what you are selling is unique. As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price-sensitive segment.
Skimming is useful when there are enough prospective customers willing to buy the product at a high price and the high price does not attract competitors.
Pricing For Different Product Life Cycles
At different stages of your product or service life cycle, you may change your pricing strategy according to your business needs. These are three normal variations that are generally used in pricing in different stages.
- Low price strategy – used to encourage trial of your product or service. As well as repurchase on a regular basis.
- High price strategy – used to generate profits to cover launch costs. A product or service may have a unique point of difference.
- Low price strategy – used the short term to stop new competitors from entering the market.
- High price strategy – used to grow profits.
Decline/ Maturity Stage
- Low price strategy – used to generate enough revenue to cover costs.
- High price strategy – used to maximize revenue in order to fund new projects.
Prices can seldom be fixed for long. Your costs, customers, and competitors can change, so you will have to shift your prices to keep up with the market. Getting this crucial business element right from the beginning should be one of your top priorities as a startup owner. Keep a close watch on what’s going on and talk to your customers regularly to make sure your pricing remains optimal.
About the Author: 99businessideas.com led by Rupak Chakrabarty is committed to helping beginners, entrepreneurs, and small business owners in starting, managing, and growing their business. Our aim is to educate the entrepreneur on the various stages of entrepreneurship.