Pricing goods and services is one of the most difficult tasks in the business arena. Many small businesses fail to make profits simply because they don’t consider all the factors needed to make prices competitive and yield that elusive profit. Before setting prices, you must understand your market, distribution costs and competition. Remember, the market place responds rapidly to technological advances and international competition. You must keep abreast of the factors that affect pricing and be ready to adjust quickly.
Retail Cost and Pricing
A common pricing practice among small businesses is to know the manufacturer’s suggested retail price. The suggested retail price is easy to use, but does have one major short-coming – it doesn’t adequately account for the element of competition.
An alternative to the manufacturer’s suggested retail price is to base your prices on those of your competitors. A small retailer, for example, should compare prices with a store that is comparable in size and customer volume. It is very chancy to compete with a large store’s prices, because they can buy in large volume and their cost per unit may be low. Instead, price products based on your local small-store analysis, and then highlight other competitive factors, like personalized customer service and convenient location. There are a number of factors that influence a customer’s decision from a certain business including price, convenience, and courteous and attentive service.
Pricing below the competition
Some vendors have been very successful pricing their goods or services below the competition. Since this strategy reduces the profit margin per sale, it pays company to reduce its costs and:
- Obtain the best prices possible for merchandise,
- Locate the business in an inexpensive location
- Closely control inventory
- Limit the line of fast-moving items
- Design advertising to concentrate on price specials, and,
- Limit other services
One word of caution: Pricing goods below the competition can be difficult to sustain. Why? Because every cost component must be constantly monitored and adjusted. It exposes a business to pricing wars. Competitors can match the lower price, leaving both parties out in the cold.
Pricing above the Competition
This strategy is possible when price is not the customer’s greatest concern. Considerations important enough for customers to justify paying higher prices include:
- Service considerations, including delivery, speed of service satisfaction in handling customer complaints, knowledge of product or service, and helpful friendly employees;
- A convenient or exclusive location; and
- Exclusive merchandise.
This approach involves selling a number of units for a single price – for example, two items for N250:00. This is useful for low-cost consumable products such as toothpaste. Many stores find this an attractive pricing strategy for sales and year-end clearances.
Cost Factors and Pricing
Every component of a service or product has a different specific cost. Many small firms fail to analyze each component of their commodity’s total cost and therefore fail to price profitably. Once this analysis is done, prices can be seen to maximize profits and eliminate any unprofitable service.
Cost components include material, labour, and overhead costs.
- Material costs are costs of materials found in the final product. For example, the wood used in the manufacturing of a chair is a direct material.
- Labour costs are the costs of the work that goes into the manufacturing of a product. An example will be the wages of all production-line workers producing a certain commodity. The direct labour costs are derived by multiplying the cost of labour per day by the number of personnel needed to complete the job.
- Remember, do not only use the daily wage, but also the Naira value of fringe benefits. Overhead costs are any costs not readily identifiable with a particular product. These costs include indirect materials, (e.g. supplies) utilities, depreciation, taxes, rent, advertising, transportation and insurance. Overhead costs also cover indirect labour costs, such as clerical, legal and other services. Be sure to include shipping, handling, and/or storage as well as other cost components. Part of the overhead cost must be allocated to each service performed or product produced. The overhead rate can be expressed as a percentage or a daily rate. This is a complex task. It is best to consult with an expert in this area. It is important to review your overhead costs periodically. Charges must be revised to reflect inflation and higher benefit rates. It is best to project the costs quarterly, including increased executive salaries and other projected costs.
Your price structure and policy are major components of your public image and are crucial to securing and keeping your clientele. Pricing for service businesses may be more complex than retail pricing. The equation, however, is the same: Cost + Operating Expenses + Desired Profit = Price.
The key to success is to have a well-planned strategy. Establish your policies and constantly monitor prices and operating costs to insure profit. Accuracy increases profits.