Setting prices for your products or services can be challenging for entrepreneurs. Dennis Zink and Fred Dunayer chat with Jack Grise and Mike Lewis, both SCORE certified mentors, regarding various strategies and things to consider when setting prices.
View a transcript of this episode here.
Published: Monday, January 18, 2016
In my nationally syndicated podcast series, ‘Been There, Done That! With Dennis Zink’ (available on iTunes) we explored some of the ways a business should use the price mechanism for profit. What follows is an edited Q& A from that interview. Joining me in the conversation were Jack Grise and Mike Lewis, both from our SCORE Pasco-Hernando chapter, and Fred Dunayer, a Manasota SCORE mentor and our podcast audio engineer.
Q: Jack, what do you mean by pricing for profit?
A: Many small businesses begin without much thought about pricing. When you ask them, ‘How do you price your product or service?’ They seem to pull it out of the air. They really don’t know what pricing for profit means. It comes down to knowing your costs, both variable and fixed. Apportion a part of the fixed costs to the overall structure, and figure out what their pricing needs to be. If you arbitrarily put a price on your product or service and don’t know what your costs are, you don’t know how much money you’re making.
Q: What do you mean by variable versus fixed cost?
A: A fixed cost is typically related to overhead, things like executive salaries, rent, insurance and bank loans that you pay statically every month. Variable costs are those costs related to whether you’re making a product or service. It’s the items that vary every month. I can’t be specific because, if you’re looking at a service-oriented business versus a product-oriented, manufacturing business, the variations will be quite different.
Q: Doesn’t the market and/or the competition determine what your pricing should be?
A: There are many pricing strategies. People often arbitrarily pick a price that they think the market will bear. One method of calculating price is called competitive pricing. Look at your competition and how they’re pricing their product or service. You can match or beat their price in hopes that you’ll be able to gain market share. Price matching doesn’t mean you can make a profit, because the competition may have something on you that you don’t know about in the sense that their costs may be significantly lower and hence they have a competitive advantage. If your costs are higher and you price to match the competition, you end up losing money and you don’t know why. It’s a form of a pricing strategy, but you need to be careful as to how you arrive at that.
Q: Jack, what’s the difference between markup and margin? People often confuse these two.
A: Markup percentage is gross profit dollars divided by cost of goods sold. That’s how much you mark up your product to hopefully gain a profit margin. Your profit margin is gross profit divided by sales dollars. If you have a 20 percent markup, that doesn’t mean you have a 20 percent margin. You may mark up a product 20 percent and only have a 4 percent margin. You need to understand the difference. Ask how much margin do you need to make? What price do you need to have in order to reach that margin and how competitive is it? What are the differentiators that will allow you to have that price?
Q: What profit margin should a business try to achieve, and does it depend on the type of business?
A: It does depend on the type of business and it also depends on your competition. A very important aspect of any business is what is your differentiator or differentiators? How do you set yourself apart? Why would a person want to buy from you versus buy from your competitor?
Q: Shouldn’t these markup and margin calculations be done before the business is started?
A: Yes, it should be in the business plan. Q: What about people who go into business and think, ‘I’ll make it up in volume?’
A: Excuse me for laughing. You can’t lose five cents on everything that you sell and make it up in volume, because you’re still losing money.
Q: What resources are available for a small business to learn about pricing for a specific industry?
A: Industry dynamics can be researched through trade publications, conferences and shows, the library, RMA data (Risk Management Association), Fintel.com, Bizminer.com and competitors. By doing research, you’re going to come across an industry standard. If your pricing and margins are not comparable to industry norms, you need to question why.
Q: What about the psychology of pricing?
A: People like value. If they perceive that they’re getting good value for their dollar, they’ll buy it. Q: What’s your opinion on having a loss leader?
A: The intent of a loss leader is to get your customers into the facility or your website. Lured by the loss leader product, the customers will see other items that they may buy impulsively. It is better to sell an item at your raw costs, rather than take a loss.
Q: What about Internet pricing?
A: Buying online is not a panacea, unless you can get free shipping. Most retailers offer their products online. My guess would be they’d be priced similarly.
Q: What are the most common pricing strategies?
A: The most commonly used pricing strategy is called cost plus. Most businesses don’t know their fixed and variable costs because they haven’t written a business plan. They probably don’t know what the competition is doing, and they don’t know what the market will bear. Market pricing has to be considered. Market pricing means that you pretest what people are willing to pay for your product or service. If you can make money, then go forward.
Q: Do you have any final comments on pricing?
A: Pay attention to your gross profit margin. Pricing is not static. Adjust your prices as needed. Know if your product is in a particular lifecycle. Is it in the beginning stage, intermediate or declining stage? Price your product accordingly, so you can maintain your margins.