When deciding how to price your products, you need to understand how – and where – your business fits into the economy.

2015_MAY_ALL_MONEY - Pricing it right

Pitching your product or service at the right price is one of the most important tasks for any business owner. Unfortunately, it’s not easy. Prices have to change as the market and the wider economy changes. Even if you get your pricing right today, there’s no guarantee it will be right tomorrow.

Your pricing strategy will depend in part on your input costs, such as raw materials, cost of labor, time and fixed overheads. But there’s a lot more to it than that. Here are some of the things I’ve learned about pricing, from more than twenty years of analysing companies and interviewing their managers.

When deciding how to price your products, you need to understand how – and where – your business fits into the economy. This can be difficult, since economics isn’t an accurate science – arguably it’s not really a science at all. It has different branches and different perspectives, some which directly contradict each other.

Most business owners would rather get on with making money than try to understand the so-called dismal science of economics. But it can really help if you make the effort. Here are some of the economic factors affecting pricing.

1. What socio-economic demographic does your target market fit into?

You can charge some customers more, but only if they believe your product or service is worth the price – and they aren’t stupid. They will need to be convinced that you’re offering something valuable in exchange.

Prices should reduce the further down the wealth scale you aim, but on the plus side you should be able to ship more units at lower prices. The trick is to balance units sold with profit per unit, and it may take trial and error to find the right point.

Remember, all customers are discerning. Or rather, they won’t buy from you unless they feel they have made a discerning choice. That’s something good marketing and branding can help you with, at all levels.

2. What age and gender are you targeting?

There are different pricing decisions to be made depending on the answers to these questions. I’m not saying you should buy into “pink vs blue” selling strategies. Rather, it’s important to recognize that, stereotypically, men and women use different strategies when it comes to making buying decisions. And young people tend to be more impetuous than older people.

These are generalizations of course, but they have a solid basis. Advertising agencies will use their knowledge of these differences to market products at each group. And the trends change over time. Consider the market for male grooming products ten years ago compared with now, for example.

3. What’s the geographical location of your customers?

Location matters. Supermarkets know this and often change their pricing depending on where in the country they’re based. This can backfire when newspapers find out and tell their readers about it, but it’s just economic reality. Business costs are lower in less affluent areas, so prices can – and often must – be lower too. So think about local financial issues when pricing your products or services.

4. Where are we in the economic cycle?

Some products and services sell well during recessions. Others don’t, but flourish during boom times. If you don’t already know where your business fits into the economic cycle, find out now. Then you can plan your strategy accordingly. This will help you prepare for possible booms and busts.

As always, past performance is no guarantee of future performance. Governments are increasingly flexing their muscles during periods of financial change. This directly influences which businesses succeed or fail.

5. What’s your primary business goal?

If you’re in business to make a regular, comfortable income then your pricing strategy is likely to be quite consistent. You’ll be aiming to make a good profit each month and build your business organically, or at least at a sustainable rate.

On the other hand, you might have a longer-term plan. For example, many technology companies rely on what economists call the “drug dealer” model. That means they sell at below cost, or even for free, to hook in customers. Then they slowly increase the price once they have a captive market. It’s a risky option unless you have the funds to burn, but the potential rewards are huge.

6. Whose money are your customers spending?

People spending their own money tend to be more cautious than those spending other people’s funds. Governments have traditionally been loose to the point of carelessness when spending taxpayers’ money. That’s partly why entire industries have grown up around them. It’s changing in some countries, but not all.

Businesses tend to be more cautious, since they have investors – including the business owner – to satisfy. Small businesses are more careful still. Your pricing will have to reflect these realities, and so will your sales strategies.

Pricing determines whether you succeed or fail

Undercharging is as bad for your business as overcharging. Either way your profits will be lower, whether due to insufficient revenue per unit or reduced sales. So effective pricing is vital. Explore your options and research your competitors’ prices (online and offline). Your pricing may have to change quickly.

Sometimes it can change upwards, not down. Always be prepared to take advantage of new market demand, which might come from unexpected places.

As the old joke about the efficient market hypothesis goes: two economists are walking along the street. One says, “Hey, that’s a $20 note on the ground!” The other one replies, “No, you’re wrong. If it was, someone would have picked it up by now.”

Economics can be unpredictable, and its effects on pricing even more so. Stay on your toes and make sure you can see the big pricing picture at all times.

Xero

This content is provided courtesy of Xero Accounting Software - used by hundreds of thousands of businesses all over the world.