Creating an Effective Pricing Strategy for a Small Business

Table of Contents:

The Importance of Choosing the Right Pricing Strategy
The Basics of Pricing
Determine Cost of Goods Sold
Account for Fixed Business Expenses
Break-Even Analysis
Pricing Analysis
A Few Pricing Strategies to Consider
Strategize for Success with TEDC Creative Capital

Most of us have watched “The Price is Right” at least every now and then and taken a guess at how much something should cost. Sometimes we’re way off the mark, but there are those special moments when the guess is spot on. When you form your pricing strategy for small business goods or services, it takes a little more than a good guess to choose the right price. 

If you’re a small business owner, you know that pricing your products and services can be a tough balancing act. You want to charge enough to cover your costs and make a profit, but you also don’t want to price yourself out of the market. So how do you create an effective pricing strategy? In this blog post, we’ll explore some tips and tricks for pricing your products and services in a way that maximizes your profits. 

The Importance of Choosing the Right Pricing Strategy for Your Small Business

Choosing the right pricing strategy is one of the most important aspects of business success. The wrong pricing structure can leave companies struggling to break even, resulting in little to no profit margins or even business failure. With the constantly changing business environment and shifting market, it’s essential to stay up-to-date with trends and adjust prices accordingly. 

Entrepreneurs should be aware of what their competitors charge for similar products and services to keep up with industry demands, innovate at the same pace, and remain competitively priced. Finding the sweet spot between overpricing and underpricing is incredibly important – getting this balance right will ensure business success in the long run.

The Basics of Pricing Your Products or Services

Pinning down a pricing strategy for small business owners is an oft-overlooked yet incredibly important part of their operations. There are some basic keys to consider before you get creative with your pricing. 

First, you have to consider the cost of goods sold (COGS) and the fixed expenses your business incurs. If your price doesn’t cover how much it costs to create your product and operate your business, you lose money every time you sell a product.   

You should also consider your market, shifts that are currently happening, your competition, and how much your target market is willing to pay. Once you’ve calculated how much it takes to break even, you can determine how to price your product to make the most profit. 

Determine Cost of Goods Sold

The cost of goods sold (COGS) is the cost of all the resources that go into producing a product or service. These costs are determined per product or service. COGS is also known as variable expenses because they go up and down based on the number of products created or sold.  

If you’re a dressmaker, you have to purchase fabric and thread for each piece of clothing you create. You may also have to pay for tags, shipping and packaging. Those costs would be factored into your COGS. The time and labor that goes into creating a product or providing a service should also be factored into COGS.  

Account for Fixed Business Expenses

Fixed expenses are your overhead costs that don’t change with your level of sales. They’re the things that are easy to predict and that you’ll pay whether you sell ten tubes of lipstick or 1,000 full make-up sets. 

Examples of fixed expenses include rent, utilities, internet service and your salary. Even if you’re not able to meet your salary expectations at the onset of your business, your desired salary should be factored into your fixed expenses when calculating costs. 

Common Fixed Business Expenses

  • Rent or Mortgage Payments
  • Electric, Water and Utilities
  • Phone 
  • Security Camera Subscriptions
  • Internet Service Provider
  • Website Hosting Fees
  • Email Hosting Fees
  • Salaries
  • Insurance
  • Loan Payments
  • Property Taxes
  • Business Licenses
  • Accounting Software or Service Fees
  • Marketing Costs
  • Professional Organization Dues

Break-Even Analysis

Once you understand your individual Cost of Goods Sold and your fixed expenses, you can calculate what it takes for your business to break even. A break-even analysis determines the point at which your revenues will equal your expenses. Of course, you’ll want to do more than break even. This is just the starting point that lets you know the absolute lowest price you’ll need to charge just to keep your business running. 

You’ll need to evaluate your realistic sales goals and decide how many products your plan to sell per month or per year. This will probably be based on an educated guess at the beginning of your business. 

You’ll take this number and multiply it by your proposed price per product to get a gross income estimate. 

This is the formula to decide if your pricing strategy supports your business breaking even:

Gross Income – Cost of Goods Sold = Gross Profit

Fixed Expenses ÷ Gross Profit = Break-Even Point

If you sell more than this amount, then you’re making money; if not, you’re losing it. You’ll need to adjust your sales goals and pricing to find the best profit margin for your business. 

Pricing Analysis

Pricing analysis is the process of figuring out how much demand and supply will shift when a price is changed. It focuses less on costs and more on where you can increase prices without a sharp decrease in demand. Pricing analysis strategies include comparing competitor pricing to see what they charge and considering your potential customer’s perceived value for your product or service.

A Few Pricing Strategies to Consider

Trying to figure out the right way to price products can be a tricky affair, but thankfully there are plenty of options you can consider. Whether you want to market your products as high-end luxury items or provide the best deal around, pricing is one of the most important aspects of your business plan. Let’s consider some pricing strategies that are tried and true across industries. 

Promotional Pricing 

Businesses use promotional pricing to offer discounts to attract customers – they lower their prices momentarily to increase demand. This tactic is great for retail businesses that want to increase interest, launch new products or sell a larger quantity of products. 

Bath & Body Works is clearly aware that promotional pricing can be an effective marketing strategy. Take the National Candle Day Sale for example. This sale cuts the price of candles in half and is often successful because it attracts long lines for this great deal even though the same candles are available all year. 

This sale increases demand for a short period of time through lowering a price to a point that gets people talking, who in turn buy more than they might otherwise. Any extra inventory may also be cleared and fresh products can be offered at a standard price.

Bundle Pricing 

A bundle pricing strategy involves wrapping multiple items together and selling them for a more attractive bundled rate. Consider a value meal at a fast food restaurant when you think of a bundle pricing strategy. If you purchase a burger, fries and a drink together, you get a better deal than buying each item separately. 

Dynamic Pricing

You don’t have to be stuck with your original price. With a dynamic pricing strategy, you can change the cost of your goods and services based on demand. This works well in the world of airline tickets, but can also be applied to businesses like vacation rentals during the summer or a holiday weekend. This strategy is also great for online-based businesses that use platforms like Amazon or Etsy sellers. 

Competitive Pricing

You focus on staying at the front of the pack with a competitive pricing model. This strategy considers what your competitors are charging for their products or services and making your price more appealing to potential customers. 

A great example of this is with everyday products like laundry detergent. Most basic products have comparable benefits. Keeping the price of your detergent in the same range or slightly lower than competitors on the same shelf is a smart option. This allows you to attract the most sales at the highest price your customers are willing to pay.

Premium Pricing

Premium pricing is somewhat the opposite of a competitive pricing strategy. With premium pricing, you evaluate your competitors and charge more than what they are currently charging. This strategy works well for entrepreneurs who want to position their brand as a luxury or high-end option. Premium pricing can be an art that communicates the perceived quality of what you offer over that of the competition. 

Starbucks is an example of a company that uses premium pricing to create a distinct image in the crowded coffee-shop market. They use premium pricing to signal to customers that they are getting something special when they purchase coffee from Starbucks. 

Price Skimming

Price skimming involves charging a premium for products with higher quality so that a business can maximize profit margins before copies of their product show up on the market from competitors. The iPhone is a great example of price skimming. 

The iPhone was once the only smartphone available, so they set the pricing standard. Now, there are smartphones from manufacturers such as Samsung that offer a comparable experience, so iPhone prices have to be somewhat competitive. 

Psychological Pricing

Psychological pricing is a common pricing strategy used across industries. Businesses use psychological pricing to take advantage of consumer sentiment – like charging $99 instead of $100 because it feels like a lower price. This is a common pricing strategy that most people have seen in television advertisements, grocery stores, and even in the pricing of apps and software. 

Loss Leader Pricing 

This strategy is often used by grocery stores and gas stations. The price of one product is priced below cost to invite customers to spend on other products while they’re at your store. The price of gas may not be set to make a profit, but owners know that visitors may stop in to buy snacks, lottery tickets or other items they’ll need instead of making a second trip to a different location. 

Versioning or Tiered Pricing 

Versioning, or Tiered Pricing, is used when a business chooses to sell a range of products at different price points. An example of versioning pricing for services is a spa owner who offers pedicures. The owner may price a basic pedicure at $40. A hot stone massage pedicure may cost $55 while a paraffin wax pedicure may cost $70. Although a customer knows they’re coming in for a pedicure, there are varying benefits with each version of the service. 

Strategize for Success with TEDC Creative Capital

As a small business owner, it’s important to carefully consider what pricing model you will use to ensure you are maximizing your profits. You can use a different pricing strategy at different points in your business journey, depending on the product or service being offered and the market conditions. By understanding different pricing strategies and when to use them, you can choose the right strategy for your business and increase your chances of success. Through TEDC Creative Capital’s business learning programs, we provide information on business strategies like finding the right price, business planning and other imperative information for Oklahoma entrepreneurs. If you’re an entrepreneur working to build a profitable business, explore TEDC Creative Capital’s range of learning programs and workshops today.