Before setting prices, you must understand your market, distribution costs and competition.
Remember, the marketplace responds rapidly to changes in supply. You must keep abreast
of the factors that affect pricing and be ready to adjust or justify your pricing based on
other factors. This is your pricing strategy
This Financial Guide does not attempt to be an in-depth discussion of pricing analysis.
Rather, it is intended only to provide a basic review of the several pricing strategies — and
perhaps encourage you to take a fresh look at your present strategies. Professional financial
guidance will be helpful in working up and evaluating the financial aspects of the analysis for
your financial resources.
Retail cost and pricing
A common pricing practice among small businesses is to follow a standard pricing formula.
The standard formula price is easy to use, but it does have one major shortcoming; it
doesn't give you an advantage over your competition.
Competitive position in pricing
An alternative to the standard pricing model is to base your price on those of your
competitors. A small company, for example, should compare prices with a company that's
comparable in size and customer volume.
Instead, price products based on a local company analysis, then highlight other competitive
factors, like personalized customer service and convenient location or some other
differentiator. There are any number of factors that influence a consumer's decision to buy
from a certain business, including price, convenience, and courteous and attentive service.
Pricing below the competition
Some companies have been successful by pricing their goods or services below the
competition. Since this strategy reduces the profit margin per sale, it requires a company to
reduce its costs and:
Obtain the best prices possible for service or product
Minimize your overhead costs
Monitor labor and inventory
Limit the service to those services that are typical
Produce advertising that concentrates on pricing
One word of caution: Pricing goods below the competition can be difficult to sustain. Why?
Because every cost component must be constantly monitored and adjusted. It exposes a
business to pricing wars. Also, if you lower your price and your competitor lowers his price,
then neither are making as much but without any competitive advantage.
Pricing above the competition
This strategy is possible when price is not the customer's greatest concern. Considerations
important enough for customers to justify paying higher prices include:
Service considerations, including delivery, speed of service, satisfaction in handling
customer complaints, knowledge of product or service, and helpful, friendly
A convenient or exclusive location
Multi-level pricing involves selling a number of units for a single price—for example, X
number of hours for $XX or Y number of hours for $YY. Many companies find this an
attractive pricing strategy for encouraging larger commitments.
Cost factors and pricing
Every component of a service has a different, specific cost. Many small firms fail to analyze
each component of their commodity's total cost, and therefore fail to price profitably. Once
this analysis is done, prices can be set to maximize profits and eliminate any unprofitable
Cost components include material, labor, and overhead costs:
Material costs are costs of all materials found in the final product. For example, the
wood used in the manufacturing of a chair is a direct material.
Labor costs are the costs of the work that goes into the manufacturing of a product.
An example would be the wages of all production-line workers producing a certain
commodity. The direct labor costs are derived by multiplying the cost of labor per
hour by the number of personnel-hours needed to complete the job.
Remember, do not only include the hourly wage but, also the dollar value of fringe benefits.
These include social security, workers' compensation, unemployment compensation,
insurance, retirement benefits, etc.
Overhead Costs are any costs not readily identifiable with a particular product. These costs
include indirect materials, (e.g. supplies) utilities, depreciation, taxes, rent, advertising,
transportation and insurance. Overhead costs also cover indirect labor costs, such as
clerical, legal and janitorial services. Be sure to include shipping, handling, and/or storage
as well as other cost components.
Part of the overhead costs must be allocated to each service performed or product
produced. The overhead rate can be expressed as a percentage or an hourly rate. This is a
It is best to consult with an expert in this area. It is important to review your overhead
costs periodically. Charges must be revised to reflect inflation and higher benefit rates. It's
best to project the costs quarterly, including increased executive salaries and other
Your price structure and policy are major components of your public image and are crucial
to securing and keeping your clientele.
Pricing for service businesses may be more complex that retail pricing. The equation,
however, is the same: Cost + Operating Expenses + Desired Profit = Price
The key to success is to have a well-planned strategy. Establish your policies and constantly
monitor prices and operating costs to insure profit. Accuracy increases profits!
As a companion to my review of the book “The Art of Pricing,” I’d like to highlight 8
pricing strategies that Rafi Mohammed, the author, offers.
Each pricing strategy asks you to use psychology with your customers. Most of
these strategies have stood the test of time — for a reason. They play to human
Try some of these strategies and see what they do for your business:
1. The Nine and Zero Effect. People associate the number nine with value and
zero with quality. Look at the difference between fast food and a gourmet
restaurant. A burger meal can sell for about $4.99 while a gourmet entree at the
best place in town may go for $30. So the psychology of pricing isn’t so much about
gaining additional sales because the price appears to be lower, it’s about what the
price communicates about your offering. So which do you want to communicate?
Value or Quality? Now you can price accordingly.
2. Payments to Promote Satisfaction. Anyone who has ever paid for a gym
membership and quit the second month has been part of this pricing strategy. If
you offer a one-time payment, customers will perceive the item free after a while
and not use it as often — thereby limiting satisfaction. Customers who pay more
frequently for a product or service use it more often and perceive more satisfaction.
So you’re better off charging monthly rather than a one time fee.
3. Prestige Pricing: Higher prices connote higher quality. Luxury brands are the
perfect example of this strategy. A latte at Starbucks has a higher perceived value
than a basic coffee with cream. Simply improving the look, packaging, delivery or
promise of your product you can justify a higher price and support a prestige
4. Anchor Pricing: When consumers are unfamiliar with a product, they will use
the highest priced model within a category as an anchor. Private Label brands in
the supermarket are a good example of this strategy. They are placed close to the
branded product and the price is typically 15% lower.
5. Quantity Suggestive Pricing: Consumers are receptive to purchasing items in
suggested quantities. This is the strategy that is responsible for my eating too
many Arby’s sandwiches. The offer typically reads “5 for $5.” When you suggest
how many you want your customers to buy and give them an attractive price, they
will do what you tell them.
6. Large versus Small Losses: Offer your customers multiple payments of less
money. Think QVC (the shopping TV channel) offering items for 4 easy payments of
$29.99 which is more appealing than $119.96. This strategy plays well with
strategy #2 — multiple payments promote greater satisfaction. So your customers
will not only perceive a lower price, but actually appreciate your offering more
because they will pay more frequently.
7. Stuffing the Bundle to Convey Value: But wait there’s more! Consumers
perceive more value when there is more stuff included in the bundle. You can even
call this a form of value-building. TV informercials are notorious for this strategy.
They introduce a main product and keep adding more and more items to the mix to
build value — while simultaneously “discounting” the retail price.
8. Everyone Loves a Bargain: Using banners announcing large discounts
increases purchases. There are two kinds of discount store shoppers: (i) those who
are price sensitive because they can’t afford to spend more, and (ii) those who are
price sensitive because they are bargain seekers and don’t WANT to pay more —
they want to feel like they got a great deal. Big “Sale” and “Discount” signs make
both sets of shoppers feel good about their purchase. If your price compares
favorably in the marketplace and you’re offering a product or service for less — tell
your customers so. Do not be afraid to show them how much less your price is or
how much more they will save.