Retailers, for example, create “markup” based on a standard factor, while manufacturers add overhead and related costs to come up with a set price. Other firms consider what the competition is charging, then either add or subtract a little to stay in line with those prices. “Overall, companies tend to use these external pricing strategies as opposed to value-pricing strategies,” says Gooze, “simply because it’s easier.”

The basics of pricing, of course, entail covering the total cost of the merchandise plus adding a margin that will yield a profit. The cost of goods—which includes the price paid for the merchandise plus freight, import duties and any handling costs—can be reduced by taking advantage of quantity discounts or time payment discounts (paying before a certain date). Operating expenses include wages, advertising, management salaries, rent, utilities and office supplies. Most of these costs are not directly attributed to any one product item, but must be spread out among all the items sold in a given time period.

Service business pricing is more complex than retail pricing, yet the price is reached the same way: cost plus operating expenses plus the desired profit. Services are more difficult to price because costs may be harder to estimate and the competition might not be as easy to compare, according to the Small Business Administration, which says many small service businesses fail to analyze the costs involved in each service and therefore fail to price their services profitably.

Value-driven prices
When Charmaine McClarie started her one-employee business consultancy in 1986, she established an hourly rate based on what she figured the market would bear. Within six months, this president of the Los Angeles-based McClarie Group knew she needed to take a different tack.

“I realized that helping a client solve a multimillion dollar problem was of much greater value to that client than the prices I was charging,” says McClarie. She then took a step back to analyze the value she was delivering to clients, factoring in the additional time spent handling tasks like preliminary research and follow up.

Every year, to cover the ever-increasing cost of doing business, McClarie boosts her hourly rate by 5 percent for all clients. “I justify the increase as an incremental cost of running a successful business,” says McClarie, who credits her early pricing insights with keeping her firm’s bottom line healthy for the last 18 years. “My strategy has worked out really well.”

“If you run a service business with repeat customers, it’s important to let them know up front that prices are subject to change,” says Alan Canton, president of software development firm Adams-Blake Company, Inc., in Fair Oaks, California.

It’s also important to give current customers plenty of advance notice if a price increase is in the cards, he adds. “Many are on tight budgets and will appreciate knowing well ahead of time about a price hike,” says Canton. “Do the same when you lower prices. Customers love to get an e-mail from us saying that we are going to lower their price.”

Ultimately, Canton says customers do understand that prices fluctuate, and as long as they’re kept informed, the small business owner won’t run into trouble instituting reasonable, justifiable hikes. “When we raise prices across the board,” says Canton, “we always e-mail our customers with a long explanation of why it’s happening, such as increased server costs or bandwidth charges.”

Think like a customer
The fact that today’s customers are more demanding than ever makes the issue of pricing particularly hard for small companies. Jay B. Lipe, president of Minneapolis small-business marketing consultancy Emerge Marketing and author of The Marketing Toolkit for Growing Businesses (Emerge Marketing, 2002), says companies are often too quick to drop prices without adjusting their level of service accordingly.

A neighborhood deli that drops the price of a popular sandwich by $2 in order to compete with a new low-price shop located down the block is a prime example. By taking this step to bring in more customers, Lipe says the deli risks financial issues if it doesn’t also scale back on its level of service. “If a customer demands a 10 percent reduction in price,” Lipe says, “you have to ask them to give something up on their end.”

Too many times, Lipe says small-business owners make desperate moves in an attempt to gain market share, without realizing how it can adversely affect their business. “They may get the business, but in the long term they’re really just shooting themselves in the foot,” says Lipe, who advises companies to first account for all direct (those costs directly related to the delivery of the product or service) and indirect costs (overhead).

The indirect costs are particularly important, says Lipe, because many times companies factor in only direct costs while overlooking costs like payroll, electricity, water and rent. Once the costs have been determined, he says, take a look at your firm’s market position and then create a pricing strategy with your customer in mind.

Mapping a strategy
When mapping out a pricing strategy, the Internet can be a great information source, says Isaza Tuzman. A few hours on your favorite search engine will turn up free reports, competitors’ websites (which may include both pricing information and details about their service offerings) and market research.

Then, ask your potential and existing clients what they think. “The key is to arm yourself with as much information as possible before making pricing decisions,” says Isaza Tuzman. “I’m always surprised at how few entrepreneurs take this step.”

Gooze cautions entrepreneurs not to get too hung up on their competitions’ pricing, since they may be using their own haphazard approach to the issue. Remember that today’s customers are well informed, thanks to tools like the Internet. Most of them can recognize the difference between “too cheap” and a “good deal.”
They’re looking for real values, says Gooze, not the low-cost leader that can’t live up to its customer service and quality commitments. “As a business owner,” he adds, “you really need to think like a customer, and not sit around hoping that the customer thinks like you.”

Successfully pricing your products or services means determining their “fair” market value, both from the consumer’s and the company’s perspective: discounted prices mean the product’s value must be perceived as worth giving up certain customer services; premium prices mean the level of service and value must be in keeping with the higher markup; either way, a fair price should yield your company a profit. Above all: Your prices must offer value equal to or greater than your competitors’.

Before pricing your products or services, ask yourself:

What are the characteristics of your customers or clients?
Do they come to you for low prices, for convenience, for service?

Do you check competitors’ ads for prices? If you do check competitors’ prices, how does your firm react to what you learn?

How often do you change prices or run sales? Does this vary by product category?

Do you advertise prices? Where?

Do you let customers bargain over the prices of any items?

How do you use prices in competing with larger retailers?

Have you formed a buying group—or cooperative—with other small retailers to get better terms on your purchases?

Do you use odd prices ($4.95, $59.95) rather than even prices ($5.00, $60)?

When you take a physical inventory, how do you compute the value of the merchandise remaining in stock? Do you plan for stock shortages when setting prices? How?