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

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
                Units

=Per Unit Price

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

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 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.

DISTRIBUTOR 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.

PRICE ADJUSTMENTS

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.
Trade discounts -- given to such people as distributors or representatives who perform some of the marketing functions.
Seasonal discounts -- can be used to encourage customers to purchase during off-peak times. This can help to lower inventory levels when demand is down.
Cash discounts -- offered to customers when they pay for their purchases in cash. This is often used by manufacturers and their distribution channel partners.

COMMON PRICING ERRORS

 

  • Basing price on current, artificially low overhead costs.
  • Assuming that because you are the newest competitor on the block, you must have the lowest prices.
  • Trying to compete head-to-head on price with larger, resource rich competitors. Try instead to offer higher quality or more individualized, attentive service.
  • Basing prices on manufacturing costs vs. on the value of product to customers. Costs may be far lower than the value of product to customers.
  • Failing to include in the price an allowance for warranty costs, future service, research and development costs, cost of capital, dealer discounts, and sales commissions.
  • Ignoring the way customer demand for the product will change at different price levels. Estimate how much sales volume might increase if prices are lowered 10 or 20 percent. At what price do you earn the maximum profit given how much customers demand at different price levels?
  • Failing to use some form of market skimming, in which you enter a market with a high price until you have satisfied demand or competitors move in, then gradually lowering price over time.

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.

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