Learn about different types of price strategies for your small business. From standard markups to value pricing, decide which pricing method is best for you. There are many types of pricing strategies depending on what type of small business you own. When deciding it is important to take your industry standards, your community, and small business goals into account.
To get an accurate view of your company’s finance to decide which strategy will work for you, it is important to track your sales and expenses in the form of monthly reports. This will help you to make the best decision for you and your company.
Standard markup is a fast and easy method to figure out how much you should charge for your goods or services. Standard markup boils down to one simple formula: actual cost + markup = price. For example, it might cost you $3 in ingredients to make a sandwich. If you set your markup at $5, then you would charge $8 for that type of sandwich.
As a small-business owner, you can use standard markup to get an idea of what you should be charging for your items. Markups depend on what people expect to pay. Customer expectations can vary wildly between different industries, and even within the same industry.
The average customer would probably not pay a markup of $20 for a small pizza. However, if your pizza restaurant offers specialty products, like vegan pizza, or is located in a trendy neighbourhood, then a standard markup of $20 might work for your business. Keep in mind that standard markup does not mean you set the same markup for all your offerings across the board.
How to Calculate Standard Markup
Standard markup is calculated individually for each item you sell, based on the item’s cost and customer expectations. A $5 markup may be a good value for a sandwich, but it’s too high for a soda.
If your business involves selling similar items or different versions of a single item, then your markup might be the same throughout your business (like setting a markup of $15 for every type of T-shirt you sell). Using one markup for similar products can simplify your pricing process, though you should always keep an eye on your sales and your stock to make sure your markup truly fits your products.
Keystone pricing can help you find the perfect pricing for your retail store. So, what is keystone pricing?
A retail industry practice, keystone pricing sets your retail price for specific items at twice the amount you paid. By doubling your cost in this manner, you set your business’ gross profit margin at 100%, making the selling price 100% greater than the cost. Keep in mind, however, that keystone pricing doesn’t mean you that your profit is 100%.
Retail Keystone Pricing Example
Let’s say you pay $100 for a pair of hockey skates. Using the keystone pricing method, you double the cost to set your retail selling price. This makes the retail price you set for your hockey skates $200. Half the $200 amount — or $100 — represents your business’ gross profit. While that might seem like you make a lot per sale, you can’t keep all the $100 of gross profit.
To find your net profit, or the amount of each sale you get to keep, you subtract direct and indirect costs such as overhead, rent, utilities, salaries, taxes, and insurance, among other expenses. Though keystone pricing doesn’t let you double your money, it typically allows you to earn a reasonable profit.
Wholesale Keystone Profit Margin
The traditional keystone pricing model applies not just to retailers who sell to the public, but also to the companies that sell retailers their merchandise so they can enjoy a reasonable profit margin themselves. Let’s say that the vendor who sold you the skates used the keystone pricing method to quote you costs for your order. By following the same example above, the vendor paid $50 for the skates that it sold to you for $100, which you then sold to your customer for $200.
Exceptions to Keystone Pricing
Retailers can’t use keystone pricing on some items, simply because some items just don’t sell at twice the amount retailers must pay. Items with smaller markups due to customers who expect low prices and fierce market competition include computers, televisions, and appliances.
All these items typically have small profit margins, and some retailers even keep their pricing for these items near the break-even point so they can possibly convince customers who arrive looking for low-price items to also purchase items with higher profit margins to go along with their new item.
Keystone Pricing in the Clothing Industry
You’ll often find keystone pricing at work in the retail clothing industry. When you sell clothing, accessories, and shoes, you typically use keystone pricing and mark your wares up 100% at the first of the season. If you don’t sell these items before they go out of season, you typically have to mark them down 50% or more to get them out of the way for more profitable items.
In these instances, keystone pricing lets you profit from the items you sell at full price and cover losses on seasonal markdowns. Additionally, many retailers adjust keystone mark-ups higher for hard-to-get items or lower to stay competitive with other retailers.
One of many pricing strategies is value pricing, which refers to setting your price based on what customers are willing to pay. The name comes from the idea that the price of a good or service is set at the customer’s perceived value of what’s being sold.
Value pricing doesn’t factor in the cost of the product or competitor prices. The goal of value pricing is to set your price as high as possible while driving away a minimal number of customers.
Where Value Pricing Works
Value pricing usually applies to a specialized good or service that creates favourable conditions for the customer. For instance, an athletic clothing manufacturer can charge higher prices for its goods if its customers perceive the gear as more beneficial than other products. Golf drivers designed to carry a golf ball further can be priced higher because of the favourable condition for the customer.
Value pricing also applies to industries where customers are very averse to unfavourable conditions. One example is the court system, where clients are willing to pay higher prices for lawyers to avoid legal penalties. The perceived value of hiring a great, specialized lawyer means defence lawyers who take on those cases can charge more.
Benefits of Value Pricing
Unlike other pricing models, value pricing doesn’t force you to charge a price close to the product’s cost or what a competitor’s charging. That means value pricing gives you more flexibility regarding the product pricing structure.
Incorporating value pricing doesn’t require research on materials costs, labour costs, overhead allocation, or competitor actions. It also has the potential of a greater impact on net income than other pricing strategies.
Value pricing overlaps multiple business departments and motivates businesses to offer the best products possible. Because the goal of value pricing is to maximize the value of one product over another, using this pricing strategy tends to help a business develop a higher-quality, more-useful product.
Finally, value pricing places heavy emphasis on the customer, and this positively impacts a company’s reputation. Companies that use value pricing often employ customer surveys, discussions, interviews, or feedback, which help promote interaction with customers and foster brand loyalty.
Impact on Net Income
The success of your pricing model strategy directly impacts your net income. While other pricing strategies limit potential revenue based on expenses or competitors’ prices, value pricing gives you unlimited potential on revenue opportunities. Your company’s brand recognition, product distinction, and perceived value to customers drive your net income.
The effectiveness of value pricing can also depend on the next-best product or service on the market. If the closest product or service is very similar to what you offer, value pricing has minimal impact because there’s little perceived additional value to the customer. Many customers may spend less on a product that’s similar if your product doesn’t offer much higher perceived value. Products that are distinct have a greater value-pricing impact on net income.
Challenges of Value Pricing
It’s important to look at the two major hurdles of value pricing to ensure the benefits are worth it. Value pricing requires an extensive amount of information and research. Value-pricing strategies are based off of customer experiences and market conditions.
These items fluctuate constantly, and it’s impossible to precisely identify an exact price to use. For this reason, another challenge to value pricing is the uncertainty. While the price assigned to a good can be substantiated by research, it’s still up for interpretation by customers.
How to Implement Value Pricing Strategy
To use value pricing, you first need to offer a unique good or service. Value pricing is only effective if customers can distinguish the increased value of what you offer compared to your competitors. This difference creates the element of perceived value. Communication is key to demonstrate value to customers.
Before pursuing value-pricing strategies, it’s a good idea to evaluate how your product line compares to the market and how to articulate this to potential customers. It’s a good ideal to anticipate customers’ questions regarding your high price point and have answers ready for them.
Another important aspect of incorporating value pricing is the lack of a fixed-equation model. As an example, a cost-plus pricing strategy combines all product expenses and assigns a mark-up percentage. Value pricing, however, requires a substantial amount of research, because each product is different, and each industry is treated differently by consumers. Seeking expert advice on value pricing whenever possible helps you learn more about changes in market approaches and strategies.
How to Price Handmade Items
The internet is a friendly place for artisan entrepreneurs, with e-commerce platforms such as Etsy and Shopify welcoming handmade sellers. You’ve created your own product and opened an online shop, and the next step is to add products.
However, you can’t add products without pricing them, and pricing your items on a whim is a sure path to an unsustainable business. Find out how to generate prices for your handmade products that account for your time, your materials, and markup, nabbing you a tidy profit with each sale.
The first step is to calculate the costs of your materials. Include the costs of any packaging used. For instance, if you wrap your bath bombs in tulle, add a branded sticker, and tie them with a ribbon, then account for the use of those materials. If your hand-poured candles are shrouded in bubble wrap and encased in extra cardboard, then make sure you write down those costs.
Undervaluing your time is the biggest mistake an artisan seller can make. You may find that it costs you $2.75 to hand-pour a candle and prepare it for shipping, price it at $10 to make a profit, and call it a day. However, if you worked for 30 minutes on preparing that candle, then you’ve only made $7.25 for that 30 minutes of work, not counting any time you spend on marketing or communicating with your customer. With profit margins that low, it’s hard to make enough money to keep operating a business.
There’s an easy pricing equation you can use to determine your pricing and avoid undervaluing your time and materials. Materials + Time Value = Item CostItem Cost x Markup = Retail Price.
For instance, if you value your time at $20 per hour and choose a 2x standard markup, then heres how you would calculate the price of that hand-poured candle that took 30 minutes and $2.75 to make: $2.75 + $10 =$12.75$12.75 x 2 = $25.50.
The retail price for your candle would be $25.50 total. You can adjust the formula to account for your own time valuation or to increase your markup as needed.
Do you plan to sell your items at wholesale? You may have a subscription box interested in your hand-poured candles down the line, or a retail shop that wants to sell your crocheted scarves. Make sure that your retail pricing accounts for wholesale if you intend to go that route. Businesses that buy wholesale generally expect a 50% discount from the retail price; if your candles sell for $25.50 each at retail, you need to be able to sell them at $12.75 wholesale and still generate a profit.
If that won’t work for you, then you have three options:
- Reduce your materials and time costs to increase your profit margin.
- Increase your retail price, which in turn increases your wholesale price.
- Opt out of wholesale.
You may find that a standard 2x markup isn’t quite right for your business, so pay attention to what items sell well and compare your own performance to competitors in your market. Some markets can sustain higher markups, especially if your handmade product is a luxury good, such as custom-knitted clothing or hand-stamped jewelry. With careful attention and experimentation, you can land on the right pricing strategy for your small handmade business.
Deciding what pricing strategy to use for your small business is a process that require a lot of forethought. To get the best results for your business, it helps to have your finger on the pulse of your retail market and stay ready to make adjustments based on costs and competition. To keep better track of all the financial factors at play in your small business, you can take the path of the 5.6 million customers who use QuickBooks. Join them today to help your business thrive for free.