How to know if your price is right
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.
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
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
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
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
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
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
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 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?
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
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
-- Updated: April 30, 2002