“Pricing is actually pretty simple…Customers will not pay literally a penny more than the true value of the product.” – Ron Johnson, former CEO of JCPenny
When starting a business, one of the most challenging decisions (and yet most important) is figuring out how to price your product/service in order to attract customers. In business, two pillars for making are profit and sales, both influenced by price. This can be the difference between success (profit) and failure.
There are many factors to consider when setting your price, but the most important principle is that the price must cover the cost – i.e. your business ought to make more money from the sale than you spent to do so. In accounting, this is better known as the “Cost of Sales”, the total cost that goes into selling the product or service to the customer. These costs are different from “running” costs of the business (like rent, electricity etc.) – and are specifically related to the product or service itself. It is incredibly important to understand and forecast these figures as accurately as possible. Failure to do so could have a huge impact on your business, so take as much time as needed.
Before getting into pricing strategy, try and consider the following items to understand the Cost of Sales of your product: What was the cost of materials or supplies? What was their delivery cost? What does your product cost to manufacturing or assemble? Are there any costs to store your inventory? How much does it cost to deliver the product to your customer? If you are selling a service, then consider costs like employment, commissions, transport, or any sales equipment. The cost of sales can also help you establish your “breakeven point” – the lowest price you can sell your goods for in order to cover their cost.
While cost of sales is a good place to start, it’s only the first step in price setting. You now need to decide how much markup (or margin) you can apply to the base cost of your product/service, which will allow you to arrive at the eventual selling price. (Remember that “margin” is not the same as profit. Your margin, less other operating expenses – like rent, electricity and office supplies – gives you your profit before tax. It is also important to account for these ongoing costs when deciding on how much markup to apply – but be careful not to push the price too high or you’ll fail to attract customers).
An important truth is that your business or product must be able to support the price you set if your customers are to accept it. You’ll need to “prove” that the value your product or service is worth the cost. In order to do so, consider the following principles:
Many of the above factors can also serve as the key drivers of your marketing and sales strategies – allowing you to position your business differently to your competitors. When starting a business, take the time you need to adequately research your competition and customers in order to set your price fairly. As the business grows, and you increase your sales volumes, you can then focus on decreasing your costs even further – which will increase your profit.
Remember, pricing is (very) important, but great businesses thrive beyond setting the right price. In the words of Jack Ma, the founder of Alibaba and for many years the richest man in China, “Never ever compete on prices, instead compete on services and innovation.”