Are you lowering your prices in an attempt to attract more customers? Lowering prices is not a sales strategy -- especially not for a small business, few of which can afford to compete on price for any extended period of time.
Instead, to attract more customers and ensure your business's continued success, it's crucial to price your products correctly.
1. Calculate your costs. When pricing a product, begin by figuring out how much it costs you to make or buy your product. This is referred to as cost of goods sold (COGS). Start by listing all the direct costs related to your product, such as materials or supplies, equipment used and labor. COGS also includes costs directly related to selling the goods, such as commissions or salaries for your sales team or the purchase and maintenance of company vehicles they use to make sales calls.
2. Assess your expenses. Next, add up your general and administrative (G&A) expenses. These are all your costs of doing business that are not directly related to making, obtaining, or selling your product. Often, you will need to separate out your overhead expenses related to COGS from those related to G&A. For instance, if your building includes a warehouse where you store inventory, the rent on that portion of the space would be considered COGS, but the rent on the rest of the offices would fall under G&A expenses.
3. Calculate your gross and net profit. Subtracting your per-unit COGS from your product's per-unit selling price leaves you with your gross profit. Dividing gross profit by gross sales will give you your gross profit margin. (For more on calculating gross profit margin and using it to manage your business, read Understanding and Computing Gross Profit Margin.) You pay G&A expenses out of your gross profit, and the money left over is your net profit. Your prices must be high enough to produce enough gross profit to pay your expenses and generate a net profit.
Other Factors to Consider
But these calculations alone aren't enough to set your product's prices. You also need to consider other factors including:
Knowing what your competitors charge. The average price your competitors charge is known as the market price, but you'll also find some competitors charging much less than the market price and others charging much more. Look at each of them and assess what factors enable them to charge higher or lower prices than the norm. Do they offer higher quality, better service or added value? How can you do the same? (For more on where to get this information, read our guide to Competitive Analysis.)
Understanding your sales channels. Depending on the sales channels you use to get your product to market, you may need to adjust prices. For instance, if you manufacture a product, or you're selling wholesale to retailers, you need to set your prices low enough that the retailers can mark up the price and make a profit. Some of the big national retailers like Walmart demand low wholesale pricing, so their retail prices remain affordable. (For a list of the different sales channels you may need to consider, read Channel Partners Help Get Your Product to Market.)
Knowing what your customers are willing to pay. You can come up with what seems like the perfect price for your product, but if customers are not willing to pay that much, you'll need to make some adjustments. Just be sure you don't lower your prices so far that you aren't making a profit. (For more on the risks of lowering prices, read Considering Cutting Your Prices: Think Carefully Before You Do and Setting Business Prices in This Economy.)
There is no one formula for setting prices, nor do prices remain static. You'll need to adjust your pricing many times over the course of your business's life, but as you gain more experience, you'll become better attuned to the needs of both your customers and your bottom line.
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