How Much Should You Charge?
For businesses of all types, pricing can spell success or failure. Different industries price their products and services in various ways. You will find the specific pricing practices used in your industry when you perform a market analysis. Start by reviewing trade journals and trade association documents and talk with businesses in your industry.
Pricing is not an exact science and businesses often experiment with several different price levels before settling on a single pricing strategy. They also may adjust their prices frequently though not so often as to frustrate buyers. The most common pricing strategies are described below. Many entrepreneurs combine their knowledge of different approaches to achieve the optimal price for their marketing strategy.
Cost-based pricing requires that businesses total all of their costs and add a percent margin or target return on top to determine the sales price. A target return is usually expressed as a percentage of total costs. Cost-based pricing has its pitfalls: it ignores the impact of consumer demand on prices. Cost-based pricing tends to work well in industries in which consumer demand and competition are stable, therefore, reasonably predictable. The calculation under this strategy is:
(Units x Variable Cost Per Unit)+Fixed Cost x Profit% Desired
COMPETITION BASED PRICING
Many businesses alter their prices based on the prices of their competitors. The risk in this type of strategy is that the cost structure of competitors might be significantly different from your own. Follow-the-leader pricing sets prices at the level of an industry's price leader. Pegged pricing establishes prices in line with the industry-wide norm. Pegged pricing tends to occur in industries in which there is no clear price leader. Pricing based on projected response by competitors takes into account the response of their competitors prior to taking action. Businesses may set very low prices to discourage new competitors from entering the market, or they may set their prices at mid-range levels in order to discourage their competitors from starting a price war.
Retail price is generally established by taking the wholesale price and multiply it by a given percentage. Many retailers double or triple the wholesale price. Retailers sell goods rather than produce them but they have labor costs and overhead associated with selling.
Consignment is the business of placing your product in the custody of a retailer who will sell it. A retailer does not buy the product from you, but pays you only after the product is sold. Commissions for sales and payment terms are negotiated between the producer and the retailer. The average commission for consignment sales is between 25 and 40% of the wholesale price.
Distributors buy products in large volume at wholesale prices and resell them to retailers. Because distributors buy in large quantities, they expect to receive a "volume discount". The products are then marked up and sold to retailers.
Businesses offer discounts of all types to buyers who satisfy some criteria that reduces their selling costs. For entrepreneurs, strategic discounting can be a powerful tool to increase sales or even out seasonal demand.
Quantity discounts -- offering lower prices to customers who buy in bulk.
COMMON PRICING ERRORS
No matter what pricing strategy you use, it is essential that it be consistent with other elements of your marketing mix. Pricing is the most telling measure of a business's marketing skills because it requires an in-depth understanding of the customer, total costs, and competition.