The current economic crisis means setting prices presents both a challenge and an opportunity for business owners.
Price your product or service too highly, and you risk losing customers for being too expensive. Set them too low, and you risk under-valuing your work and not creating enough income to cover costs.
Despite the challenging economic times, the core principles for pricing strategies have stayed the same.
In this guide, we will look at:
- Five vital factors to consider when setting your prices
- Understanding pricing strategy: gross and net profit
- Cost vs value
- Building brand equity to justify your price
- Building trust in your brand
Five vital factors to consider when setting prices
The most crucial step is to have a solid understanding of your finances.
Before setting your pricing, work out the costs of running your business. These include:
- Fixed costs (the expenses that will come in every month regardless of sales)
- Direct costs (the expenses you incur by producing and delivering your products and services)
Think about what your customers want from your products and services. Are they driven by the cheapest price or by the value they receive? What part does price play in your customers' purchasing decisions?
Critically evaluate what you are selling. Are your current customers buying high-end or low-end products and services?
This information will help you determine if your price is right.
After grasping your customer's perspective, it's essential to consider your market position.
Does it make sense to position yourself as the premium, luxurious, high-end brand with the highest prices?
Once you have decided where you see your products sitting in the market, you will start to get an idea of your ideal pricing.
Allow yourself some time to do a little competitor research. Find out:
- What does your competitors' pricing look like?
- What are they charging for different products and services, and how have they structured this?
- What inclusions are they offering for those prices?
- What customers are they attracting with their pricing?
- How are your competitors positioned in the marketplace?
The answers to these questions will give you an industry benchmark for your pricing.
Small business owners frequently overlook a fundamental question: "What is my desired profit?"
Often, they observe competitors' prices and randomly select an amount to stay competitive, neglecting their own profit goals. So, give careful consideration to answer this question, and be sure to base it on what your time is worth.
Understanding pricing strategy: gross profit vs net profit
To get your prices right, you must have a genuine understanding of the cost of delivering the service. While total sales can offer insights into your business performance, they are only part of the picture.
Often, individuals emphasize gross profit when they should focus on net profit.
For instance, selling an item for £10 after purchasing it for £5 might seem promising at first glance, but you won't generate much profit if the cost of delivering the product or service amounts to more than your £5 margin.
So, what's the difference between gross profit and net profit?
Gross profit is the revenue a company earns from its sales. It's calculated by subtracting the cost of producing the goods or services sold. It doesn't take into account all the other expenses you'll incur.
Net profit is the final amount a company earns after subtracting all expenses. This includes the cost of goods sold, operating expenses, taxes, interest, and other deductions from total revenue. So net profit is what you should be looking at when considering your pricing strategy.
Rather than calculating the gross profit of individual sales or deals, focus on the total net profit of the whole business. When you understand what your net profit is currently, this will help you to see if your prices are correct.
Understanding cost vs value
A common mistake is only pricing services based on commodity prices and basic costs. If you only use your expenses to set your prices, you undermine the value your service brings.
Instead, set your prices on a value-added basis.
When deciding prices, consider the total value you provide for your customers beyond the basic costs to deliver your service. It's essential to assess the value of your brand and the service you provide.
The brand can (and should) transcend the value of the services. A premium brand which creates positive emotional reactions should translate to a more significant profit margin.
For example, Mont Blanc sells a range of luxury fountain pens, some retailing for over £8000. Their capacity to set such elevated price points stems from their established status as a premium brand in the market.
You can do the same thing with the products and services you provide. Start by positioning your brand as a luxury or 'best in market' brand. Higher prices often make your product or service more desirable despite what you may think. In economics, this is a concept known as 'Veblen goods'.
A Veblen good is a product for which demand increases as the price increases. Veblen goods are typically high-quality, well-made, exclusive, and a status symbol.
You can apply this logic whether you sell products or services. If you align your business as a premium product or service, your customers will value you as such.
Competing is about the brand, not just the price
In today's business landscape, it's vitally important for every business to try and elevate itself. Focus on building brand equity to increase your net and gross margins.
As business owners, we all need to avoid pricing based on the costs of delivering our products and services. Cost shouldn't be the sole factor when setting your prices. Your business needs to have high brand value and awareness.
Consider who or what primarily determines your prices: you, customers, or the market.
It is vital to review your prices and compare them to competitors regularly. It can help as a benchmark, especially in a highly competitive market.
If you're going to set higher prices than competitors, you need to demonstrate the value of your brand compared to others. In less crowded markets or with distinct offerings, you have more flexibility when setting prices.
Increasing trust in your brand
One way for a company to grow its value is to work with a brand growth consultancy. They can show you how to create a pricing strategy based on the value of your brand.
In these challenging economic periods, businesses, like consumers, will gravitate towards brands and services they can trust and rely on. So reward that by pitching prices at a level that allows them to stay with you. That way, when the economic tide turns, customers and clients will be far more likely to increase their investment with you.
About the author
Matthew is a multi-award-winning founding entrepreneur and CEO at Champions UK, a business consultancy firm. He specialises in working with entrepreneurs from start-ups through scale-up to large Cap Private Equity and IPOs. He is a Fellow of the City of London Company of Entrepreneurs and a Freeman of the City of London.