Pricing strategies – how do you set yours?

One of the most important decisions to be made when launching a product or service. is setting the price. Ultimately you will want to make as much profit as you can from each sale, with prices set at the highest point possible before demand starts to decline, but numerous factors will influence your pricing structure.  For a start, you must consider your business objectives for example, if your aim is just to maximise profits, you may set a higher price than if your objective is to increase market share or grow sales.

Here are some of the issues you need to consider.

Cost plus

A popular and simple method of pricing a product or service, is to calculate the costs of producing it and then add a profit margin. For example, if it costs £10 to make a product and you decide on a mark-up of 50%, the sale price will be £15 (and the gross profit will be 33.3%).

However, when using this method, it is important to take into account all costs. Some 'direct' costs will be obvious such as stock, materials, employee wages, storage, packaging and delivery. But you must also be aware of 'indirect' costs, such as rent, utility bills, insurance and depreciation of equipment. You may need our advice when analysing your total costs.

The down side of the cost plus method is that it doesn’t take into account such factors as competition, market trends or the needs of the customer.

Target cost

It can be difficult to compete on price if production costs are relatively fixed. Target costing is a solution to this problem and is almost the opposite of the cost plus method. When launching a new product, you decide on an optimum selling price from the outset and then subtract your desired profit. The result is your target cost and all involved in design, development and production are tasked with meeting this cost. However, setting the initial optimum selling price does require extensive market research.

Market skimming

This strategy is most often used when launching a new product which is unique to the market. The idea is to take advantage of being the first to market, by setting a high price with a greater profit margin than normal, thus making as much profit as possible before competitors are able to bring out similar products.

Penetration pricing

The opposite of market skimming, this is commonly used when trying to launch new products in an already popular market, or when selling an existing product to a new market. The strategy is to offer an initial low price in an attempt to gain market share before raising prices.  Magazines frequently take this approach, offering early issues at very low prices in an attempt to attract loyal readers, who will be willing to pay more for subsequent issues.

Price matching

Prices are set by mirroring competitors’ rates, without attempting to undercut the 'going rate'. If your business is dominant in a marketplace, you may be able to dictate this rate.

Destroyer pricing

This is an aggressive high risk strategy designed to eliminate competition. Quite simply prices are lowered to the point where competitors are unable to match them and consequently go out of business.  A great deal of confidence in your knowledge of your own and your competitors' capabilities is required before attempting this and it is not generally recommended.

Competition and customers

Customers buying standard products available from numerous sources will generally look for the supplier with the lowest prices. This can make it difficult for the small business to compete with large companies, who can mass produce and purchase in bulk.

Consequently, many successful small businesses don’t attempt to compete by lowering prices, but instead focus on other areas such as perceived quality, customer service or the uniqueness of their brand. Indeed, if you are marketing your product or service as high quality or 'luxury', customers will expect to pay more and a cheap price may actually harm sales.