Price Setting : How to Set your Prices Effectively
Setting prices is considered a "black art" by many people in business. Yet your ability to effectively set prices has a profound impact on the success and profitability of your business. There are 2 very simple activities you can complete to get a better grip on your pricing. In this article we will outline those 2 activities and some very simple exercises you can complete to begin pricing more effectively.
What is "effective" pricing?
Effective pricing achieves a number of outcomes for your business. It:
- Maximises your profitability
- Focuses clients on the outcome and value delivered
- Enables you to have healthy cashflow
- Builds competitive differentiation
- Delivers your business strategy
Improving your pricing strategy isn't just about putting your prices up. You need to think widely about the implications for your business.
The facts about pricing strategy:
- There are a number of different ways to go about setting prices
- Each method has its strengths and weaknesses
- The key to setting prices effectively is to learn what you can from each method and use that knowledge to identify an optimum price
- Whichever method you go with there will be a degree of experimentation before you discover the optimum price.
1. Use Different Pricing Methods
There are a number of pricing methods you can use to determine the most effective price for your product or service. Most industries by tradition have a dominant pricing method they use. For instance, professional service firms traditionally charge by the hour. Commodity products such as some food items charge at the going rate.
Here are a list of the most common pricing methods and how you calculate them:
- Hourly rate : Desired income level divided by potential hours of work
- Cost plus : Adding a standard mark up to the cost of the product / service
- Value based : Determine what the buyer perceives as the value of the product
- Proportional : Price set in proportion to a larger project / product / sale
- Going rate : Charge the same as your competitors
To begin understanding your optimum pricing point try applying some of these different pricing methods to your situation.
Choose one of the pricing methods from the list above that you haven't used so far. Imagine that method was the only one available to you. How would you need to change the way you structure and position your products or services to utilise that pricing method? What price would you choose?
Experiment with a few of the different pricing methods and some trends will start to emerge. Your calculations will tend to all arrive back a certain price range. This gives you the ballpark of where your pricing should be.
2. Test Price Elasticity
Price elasticity is a term from economics that describes the extent to which a market will wear changes in pricing. Most business owners don't understand or appreciate just how elastic prices are in their markets. The case studies provided by Eyes Wide Open clients suggest most customers of small businesses will easily absorb a 5 - 15% increase in prices with indifference. That sort of increase has a direct, positive impact on your bottomline.
We find business owners tend to simply forget that they can experiment with their pricing. Large corporations do it all the time, just look at how our supermarkets and petrol stations change their prices so as to optimise their profitability. We need to learn from their example.
There are a number of ways to test price elasticity. When working with our clients we typically suggest they start testing on a segment of their total customer base. If you are a service firm then you may choose to test with C or D level prospects. If you are in retail you may choose to do your tests on different (perhaps quieter) days of the week. The idea is to test your pricing on a contained low risk segment of your customer base to limit any negative implications if you get it wrong. Then simply start to increase your prices in small but measurable increments. Perhaps you put your prices up by 5% and see the reaction. Then 10% and again wait and see the reaction. If you work on commissions perhaps increase commission by 1% at a time. You will know when you hit your upper limit because people will start to hesitate to purchase.
Solid Marketing Strategy Required
Experimenting with different pricing methods and testing for price elasticity are 2 methods you can use to help you set prices more effectively. However you need to remember that whatever price point your choose it can only be delivered and sustained through effective marketing. You need to ensure your market clearly understands your value proposition and benefits otherwise they are unlikely to pay for your goods and services no matter what price you charge. With all that said, keep your mind, and eyes open, to the possibilities of pricing strategy and use it proactively to drive the success of your business.
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