One of the most vexing problems facing many small businesses is coming up with suitable prices for their products and services. For example, some new businesses will launch with heavily discounted prices in an attempt to build a sizable customer base quickly and establish a foothold in their market. Others will charge premium rates, but fail to show how the customer will get added benefits for the higher cost. Finding the sweet spot in pricing involves research, testing, patience, and an unwavering belief in the value that the small business provides.
Know your expenses
"You have to start by looking at all of your costs. This is where [many] people go wrong," says Janet Attard, CEO of Business Know-How. "Also, if they're starting out as a one-person business, they don't think ahead to when they will need employees and how those costs may change."
Businesses generate both seen and unseen costs that need to be taken into account. For example, besides obvious overhead expenses—such as employee compensation and benefits, insurance, Social Security taxes, office supplies, rent, and utilities—Attard says that business owners often forget to pay themselves a salary and factor that in their monthly expenses. And while a business that sends workers out on the road, such as plumbing, will take fuel and vehicle maintenance costs into consideration, the costs of running the office while the technician is on call need to be calculated, too.
There are a variety of ways to find out standard pricing in a given niche. "You can simply talk to the people in your industry and find out what they’re charging," Attard says. "Or look up people in noncompeting areas and find out what they're charging. Sometimes you can find out from customers themselves what they usually pay." She also recommends the Small Business Administration's pricing guide.
Charging the lowest price for your goods and services may actually backfire in some circumstances, Attard warns. For example, new businesses that significantly undercut their competitors in the business-to-business sector may make the customer think that they won't be able to handle the job successfully or that they are desperate for work. On the other hand, businesses that charge higher than average must prove that they offer and deliver more than the competition. "For somebody just starting out, coming in the middle range of the going prices may be a good idea," Attard says.
Businesses that have a clear idea of who their customers are may find it easier to set their prices and cater to their audience. "It's not like you have to [sell to] everybody," says Bob Phibbs, CEO of The Retail Doctor. "It's okay to turn some business away. Some retailers in particular deal with hagglers who believe you're gouging them to begin with. You don't want to attract those kinds of customers."
The actual retail store experience can affect how you set prices as well, Phibbs says. For example, customers who shop at a neighborhood grocery store that displays produce in makeshift bins might expect to pay less than what an upscale retailer with nicer lighting and artful presentations would charge for the same products. "Self-image can play a huge factor in how you price your merchandise," Phibbs explains.
While consumers may find cheaper prices for some products online, a brick-and-mortar retailer that has the item in stock at a higher price may make the sale, simply because the item is available then and there. "Americans are getting very, very tired of waiting," Phibbs says. "A good small business is going to help people see that and [prove that] advantage to the customer in front of them."
"The first time I set prices, I didn't have a clue [about what I was doing]," says Naomi Poe, founder of Better Batter Gluten Free Flour, a Pennsylvania-based allergy-free baking mix company. "At the time, our industry was not developed, so there wasn't anything to compare against. I just took my costs and multiplied them by two. I happened to come in right where people wanted to pay, but I don't necessarily recommend [my experience] as a pricing strategy."
Since that less than well planned out opening in 2006, Poe has taken a more systematic approach to pricing her products. Today, after calculating her operating expenses and profit margins, she surveys her biggest competitors in North America and compares their prices, and then works backwards until she comes up with a price that fits her business's position in the marketplace.
"It's all formulaic, but at the same time there's a lot of consumer psychology in there," Poe explains. "You push the numbers up and say nobody's going to buy at that price. You push the numbers down and say we can't afford to do it that way. So you keep calculating until you find the right point."
Poe works consistently to maintain a transparent, loyal relationship with her customers. She notifies them in advance when outside forces—such as rising fuel or commodity prices—are about to send her prices higher. Conversely, Poe rewards them with lower prices whenever possible. For example, when she was able to reduce the packaging costs on bulk orders, she passed the savings on to her customers. Poe also offers stable pricing options whether a purchase is made online or in-store, protecting both the retailer and the consumer.
According to Poe, she only had sales of $3,000 when she opened in 2006, but racked up $705,000 in sales last year. "Transparency and honesty in this day and age are as important as product quality and bottom line price," Poe says. "If you do right by your customer, they'll do right by you."