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How to know if your price is right

Knowing when to raise pricesWith fuel prices, insurance premiums and labor costs on the rise, more small-business owners are eyeing their price tags and wondering -- is it time to raise prices?

For an increasing number of small-business owners, the answer is "yes." But before getting out the magic marker, experts say small-business owners need to look at the three Cs: your costs, your competitors and your customers.

Costs establish a floor for your prices. Competitors give you a range of pricing possibilities. Customers set the ceiling beyond which they won't go.

Costs
Surprisingly, what a product costs should only play a minor role in how it's priced. But until you know what you need to make to cover expenses, you won't know where the floor is on your product's "price-abilities."

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The break-even analysis is one of the traditional methods for determining that floor.

To find it, you first need to know your fixed overhead costs, such as rent and administrative salaries. These will remain the same no matter how many widgets roll down the assembly line.

You'll also need to know your variable costs for each unit you sell. Variable costs include raw materials, direct labor and marketing costs.

And, of course, you need to know the price you want to charge.

Now, let's make up some numbers and do the math.

Let's say your fixed costs are $90,000. Your selling price is $24, and each unit has variable expenses of $16. The difference between the variable costs involved in creating and selling a specific product and the revenues it brings in is called a contribution margin. In this case, the contribution margin is $8 per unit.

Fixed costs divided by your contribution margin gives you the number of units you need to sell to reach your break-even point.

In this case: 90,000 divided by 8 = 11,250. You need to sell 11,250 widgets to break even.

We have prepared a downloadable Excel template for you to use to calculate your own break-even point. You can also use it to construct different "what-if" scenarios to see how raising your price or lowering your costs affects your break-even point.

Your competitors
Your customers use your competitors' price tags as a benchmark for comparison. You should, too.

Questions to ask

Jim Reser, who heads the Small Business Development Center in Durango, Colo., suggests that small-business owners who are contemplating raising prices ask themselves the following questions:

  • What is the competition doing?
  • How will a price increase affect my current customer base?
  • Will a price increase affect my ability to attract new customers?
  • Will the price increase I make today meet my needs for a long time or a short time?
  • When will I have to consider another price increase again?
  • Is the proposed price increase high enough?
  • Is there something about the that way I announce my increase that will help customers see the true (higher) value they are receiving, rather than just the dollar amount of the increase?

Spend some time profiling your competitors and their prices. Look for differences and similarities in your products and services. Does your company provide faster service? Do you offer more convenient operating hours or friendlier service? All of the factors can play into a potential customer's perceived value of your product.

Your customers
Your customers' sensitivity to a change in prices plays an important role in any pricing decision. But finding out just how price-sensitive your customers are can be a challenge, says David Bell, who teaches marketing and researches pricing issues for the University of Pennsylvania's Wharton Business School.

"Getting people to reveal their true reservation prices (the most they will pay) is quite hard," Bell says. Trial and error -- testing out customer responses to different price points -- is a good method for determining the right price, he says.

Often it's not the price, but some other feature of your product or service that brings your customers back. Understanding how your customers value the benefits of your products will help you predict their reactions to a change in price, Bell says.

Think about what your customers are getting when they buy from you. A good product at a low price? Advice? Fast service? Quality? Convenience? What distinguishes you from your competition in your customers' minds?

Ringing in the new
Once the new price is in place, you can market it to the various segments of your customer base with special pricing or value-added product packages.

You can ease your price-sensitive customers into the price increase with coupons or specials that will allow them hold the line on prices if they order during a specified period.

Segmenting your market allows you to reach out to another level of business you might otherwise miss. Movie and theatrical matinees, early bird specials and discount coupons are three of the many ways small businesses increase revenues with selective pricing.

-- Updated: April 30, 2002

 

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