How to develop a pricing strategy

The prices you charge can have a dramatic effect on sales and profits. They can influence how customers respond to your product or service. Pricing can mean the difference between success and trading at a loss.

Consider these two pricing factors:

1. What the market says

You can get valuable guidance by conducting research on the market reaction to similar products or services as your own.

  • Which are seen as offering the best value?
  • Which are likely to be the most successful?
  • What do customers expect to pay for them?
  • Is there an established market price for similar products or services?

Compare buyers’ risk on each product or service you research. You could charge a higher price if you can reduce or reverse the risks of your product or service.

2. Your competitors

To some degree, your price will depend on the competition. Look at your competitors, the key benefits and features of what they offer, and any points of difference you can see in your own product or service.

If you’re able to offer more (for example, better quality or more features), you can afford to charge a higher price.

Your pricing strategy

An appropriate pricing strategy complements the position of your product or service. For example, a high price will likely suggest a premium value to your customers.

Cost-plus pricing

Cost-plus is a necessary starting point to avoid under-charging. Simply calculate your production costs and add the amount you need to make a profit. Just make sure you’ve calculated all your costs. Consult your accountant to ensure accuracy.

Cost-plus will tell you whether the prices are viable. Charging less than the direct cost of a sale can lead to a significant loss, while charging more than your direct costs will see each sale contribute to your fixed costs (or overheads) and towards a profit. The contribution each sale makes will tell you what volume you need to sell to reach break-even.

However, cost-plus doesn’t take into account:

  1. The level of demand.
  2. What competitors charge.
  3. Market expectations (what customers expect to pay).

Consider these factors before making your final pricing decisions.

Benchmarking your costs

It’s useful if you can benchmark your costs against industry averages, like gross profit and net profit margins. If your margins are below industry norms, it could suggest your costs are too high or your prices are too low.

Industry margins also give you a rough guide to the prices you could achieve when considering new products. Consult your accountant for help with benchmarking figures.

Price differentials

Varying prices can increase your profitability. You could:

  • Charge lower prices for high-profile products to capture customers who will also buy higher margin products (a ‘loss leader’ strategy).
  • Charge different prices at different times to reflect changing demand.
  • Charge different prices for different levels of service or specification.

Discount carefully

Most accountants warn against discounting. Once you actually work out how much extra you need to sell to cover a discount, their concern becomes understandable. This is why you never start a discounting battle against stronger competitors – nobody wins except the customer.

However, discounting can work in certain circumstances. For example, clearance discounts can help you sell off old stock, release working capital and improve cash flow.

Continually review your prices

  • Review prices regularly to ensure you’re keeping up with trends in your industry and the overall market.
  • Under-pricing your product can be even more dangerous than over-charging. Remember, while prices are low, so are your margins.
  • If you cut prices, customers may not respond if they perceive new prices as signaling low-quality or a lack of confidence and experience.
  • Changes in turnover can signal a problem or an opportunity. For example, if you sell products with high or growing market share, you could increase prices. Similarly, if you tender for business, too high a success rate suggests you’re under-pricing.
  • If both your margins and market share are low, you need to change something – or consider discontinuing the product.

Increasing your prices

Increasing prices and therefore margins can sharply increase your profits – even if your turnover drops. However, you should always explain to your customers why you’re increasing prices and give them fair warning, especially if they need to budget for the increase.

  • Use the price change to re-emphasize the benefits you offer. Good relationships with your customers can help to improve their value perception and lower the risk of them trying alternatives.
  • Always increase the price by more than the cost of improvement.
  • In general, always consider increasing prices when demand is high.

Next steps

  • Research customer reaction to prices of comparable products and services. Consider whether your business can justify higher prices.
  • Seek help from your accountant with developing your pricing strategy.
  • Schedule regular pricing reviews to keep on top of changing demand, market expectations, seasonal trends, industry trends, and changing production costs.
  • Communicate any price increases to your customers and use the opportunity to re-emphasize the benefits your product or service offers.

© Comerica. For more content like this, please visit smallbusiness.comerica.com