How to Find the Sweet Spot When Setting Prices
Price setting involves various factors, from analyzing and predicting consumer behavior to more pragmatic approaches like pricing a product in line with the competition, regardless of the differences in perceived value. Whichever method you use, one thing is clear: The way you set your prices will greatly determine how profitable your business becomes.
Simply guessing at price points leads to lower profits and less market credibility, says Frank Goley of ABC Business Consulting. He recommends a well-planned strategy based on your break-even point.
To find your sweet spot when setting prices, consider the following:
1) Figure out your cost per item. You need to know exactly what it costs to produce the product(s) you sell. Understanding production costs — an area often overlooked by small-business owners — is extremely important in determining each item’s price, Goley says. To figure out your cost per item, add up all of your expenses directly related to manufacturing and selling an item, including raw materials, shipping charges, commissions, and labor fees.
2) Determine your annual fixed costs. Fixed costs consist of the other operational expenses that your business incurs on a regular basis. Rent, property taxes, and employee salaries fall into this category. Add up these payments for a year to arrive at your total annual fixed costs.
3) Find your break-even number. How many units of a product must you sell in order to break even? Anything above this number will be considered profit, and anything below it will count as a loss. To get to this number, subtract the cost per item from your preliminary target sales price, and then divide your fixed costs by that number. Use competitor’s prices initially as your target price, and then adjust the numbers as you solidify your pricing goals. The final figure is the number of units you’ll need to sell in order to break even. For example, let's say your fixed costs are $50,000 per year. You charge $100 per item, and you’ve determined that your cost per item is $20. You’ll have to sell 625 units per year to break even at that price.
4) Set your price. Once you have your break-even number, you’ll be able to adjust your price according to your goals. For instance, you might charge more to try to reap higher profits for less work, or you might charge less to enter a market that's already established. In either case, Goley warns that you should remember the value of your product. “It’s the value component that is often missed in pricing, and where the real profitability and margins exist,” he says. For instance, many customers perceive value in terms of the time that they save when buying a product, so a supplier who offers thousands of variations of a product in one place may be able to charge more than his competitors who only offer a limited selection.
Suzanne has been a full-time freelance writer for 20 years. She’s written for numerous business and financial publications such as Entrepreneur, Reason Magazine, Home Business Magazine, and Money Crashers.