5 Factors to Consider When Setting Prices

by Dave Clarke on January 30, 2014
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The legendary psychologist Sigmund Freud is thought to have said, “Sometimes a cigar is just a cigar.” That may be, but price is never just about price. The psychology of pricing involves much more, including perceived value and marketplace competition.

When setting prices, small-business owners typically take into account the cost of goods, the overhead affiliated with the sale (rent, utilities, payroll, etc.), and what the competition charges for similar offerings. But, in order to find the optimal price, experts say you need to do more.

When pricing your goods and services, keep in mind the following:

1. Degree of DifferentiationTed Zoller, director of the Center for Entrepreneurial Studies at the University of North Carolina’s Kenan-Flagler Business School, explains that the more you can differentiate your goods and services from the competition’s, the better your odds of sustaining a higher price for them.

This is particularly true when you sell a commodity. “The degree to which you can differentiate your goods from the competition’s — the more unique you can make them seem when being purchased from you — the more flexibility you have in pricing,” Zoller says.

For example, Five Guys sells burgers and fries like other fast-food chains nationwide. Yet by offering “unlimited toppings” (onions, lettuce, pickles, condiments) and a beef patty somewhat better than that of the fast food chains, Five Guys is able to charge far higher prices than its competitors. The chain gets nearly $11 for a burger, regular fries, and a large drink, whereas a Big Mac meal at McDonald’s sells for about half of that.

If you run a service-oriented business, Zoller suggests that your odds of winning the pricing war increase when you find ways to show your customers that you deliver value over time. “It shouldn’t just be about the price for a single service unit,” he explains. “It should be about the intangible assets you bring to the relationship, such as how you solve your customers’ problems or address their overall needs better than the competition [does].”

2. Degree of Transparency — If you’re fortunate enough to operate a small business for which pricing is not readily transparent (i.e., easily available online) and thus customers cannot easily benchmark the competition, you have a relatively higher degree of flexibility in your pricing options (see #5).

But if you operate in a world where pricing is transparent, find ways to make apples-to-apples comparisons difficult, Zoller says. That can be accomplished in various ways, including different packaging of goods, custom bundling of goods or services, or unique discount strategies.

For example, if you sell running shoes, you could help customers find just the right pair for their feet by including a free gait analysis with every purchase. Zappos can’t do that.

3. Degree of Scarcity and the “Cool” Factor — Look for opportunities to create scarcity for your goods or services. “If you can create a perception that yours is the only place people can get this solution, that you offer the best fit for their needs, you can practically name your price,” Zoller says.

Some companies are masters at making their products seem cool. These are the places where you see lines out the door even when nothing is “on sale.” It could be a clothing boutique, a coffee shop, or an electronics manufacturer.

For example, many companies make smartphones and gadgets. But Apple, with devices like the iPhone, iPod, and iPad, is the grand master of creating a “cool” factor. As a result, its products are highly sought after, and the company charges a premium for them. The bottom line: When your brand has cachet, the issue of price fades into the background.

4. Degree of Connectivity — Perhaps nowhere was the disruption of the status quo brought about by the advent of the internet more impactful than among small businesses. And the way both bricks-and-mortar and e-commerce ventures use the web continues to evolve.

Bricks-and-mortar establishments are using their online platforms to engage with customers outside the store and learn how to elevate the value of their brand. E-commerce enterprises are using their websites as laboratories to conduct research, leverage showrooming to test price and service offerings, and learn how to best position their brands.

In 2012, electronics and appliance retailer Best Buy was among those fearful of its customers’ ability to comparison shop via mobile devices. By 2013, the company flipped its position and ran a showrooming campaign to address the issue head-on. Its efforts paid off: Best Buy used what it learned and offered a low-price guarantee to increase sales and profitability.

5. Degree of Flexibility — The future, some experts say, may be in dynamic pricing. Some merchants are already using data they’ve collected about their customers to structure offers based on buying habits in real time.

An airline, for example, may see that you’ve searched for travel between two destinations and, if you didn’t complete the purchase, email you later with airfare discounts and opportunities to purchase hotel stays, car rentals, or other related packages.

Similarly, Uber, a San Francisco-based car service, uses dynamic pricing to increase rates during peak demand times (such as rush hour, during bad weather, or on New Year’s Eve), a strategy which Rafi Mohammed, author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow, calls “the future of business.”

Of course, small businesses may not have the resources for such sophisticated use of “big data.” But they can nevertheless tap whatever information they have about their customers, individually and in aggregate, to design offers and discounts to boost sales and profits.

Dave Clarke is a business writer for Intuit and is passionate about solving small business problems.

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