In our last ‘Tips & Tricks’ issue, we discussed The Danger of Competing On Price Alone. We warned against using your pricing strategy alone to be competitive; however, we did not discuss how to set your pricing. For some, this is easy to calculate. For others, it takes some trial and error, to learn what the ‘market will bear,’ so allow you to achieve the profitability with which you are happy.
There are many business books and guides that help you though a specific bell curve calculation of profitability. Understanding the concept is helpful, especially in visualizing where your profit is most optimal – not too high, as to be priced out of your customers’ reach, or too low, as to not being able to make a profit, regardless of how many customers you have.
Most small business owners, however, unless they are natural ‘number crunchers,’ are simply are not interested in taking the time to research and calculate the optimal price point. They just want to get to the point…set a price and get on with the business at hand.
So, here’s the gist of pricing for your business.
If you’re just starting your business, you will need to make some assumptions about the future, and adjust as you go. If you have been in business for awhile, you have some data with which to work (hopefully, saved in a bookkeeping software, to make the calculations quicker and easier). So, what numbers to you need? (Due to fluctuations, we recommended using annual numbers.)
1. Projected Indirect Costs of Business
What are all the costs you incur to provide your business? This includes all costs that stay relatively the same, regardless of whether you sell anything or not – building, electricity, phone, internet, supplies, advertising, employees, etc.
2. Projected Direct Costs of Business
Now, this is a bit tricker, as you need to decide how much of your product or service you will sell, and what the cost will be for the inventory you need to purchase to provide that product or service. For example, if your goal to sell 1000 widgets in the next year, and they cost $2.00 to make, your direct cost is $2000.
3. What Profit Do You Desire?
Here’s where you simply decide how much money you want to make for the year.
4. The Calculation
Direct Costs + Indirect Costs + Desired Profit /
Number of Items or Services You Will Sell to Customers
= Price to Charge
Obviously, very few of us sell only one product or service. Support4Business offers four main services: bookkeeping, web design, computer repair, administrative assistance. Based on historical data, with this simple calculation, I can determine a very rough price per hour as a starting point. Then, I adjust the hourly pricing by service, based on technicality.
In the beginning, like most businesses, I set my pricing with one premise – Get Business. That worked, but it was not at all profitable. Of course, at the time, it was just a hobby and generated a bit of extra income. When I started to see the business as having a potential to financially support us, I had to seriously evaluate my pricing model. I did lose some customers in increasing my pricing, but these were just looking for cheap service and were not respecting my skills. In researching what similar businesses were charging in the region, I found that many clients are willing to pay a reasonable price, and I was finally able to garner a profit.
So, in the beginning, I went at it backwards…calculating in the profit should have come first. Now, if my profit-desired calculation had made the price per hour (or per item) out of reach for potential clients in my area, then I would need to see how the direct and indirect costs could be reduced. It is pointless to have a price point set for profitability, when no one will pay it…unless you can use some of the tips provided in The Danger of Competing On Price Alone, to make your product or service more valuable in the eye of the customer.
And if we can differentiate ourselves in perceived value, we will be in the unique and desirable position of exceeding our profit projections. I cannot think of a better place to be.
If you need assistance in determining how to make your business more profitable, we welcome you to contact us for an evaluation.
UPDATE: I recently enjoyed a related SCORE webinar, titled “The Power of Pricing.” Great resource! There is also a Pricing Strategy Worksheet included.
Until next issue…Best wishes in your endeavors!