Business Plan Center

Four steps to setting prices

How should you price your products or services? Here are four steps that can help.

Published: April 24, 2015

Pricing your products and services can be more art than science. Overcharge your customers, and they'll go elsewhere. Undercharge them, and your profit margins may suffer the consequences. So how do you find the sweet spot? Here are four steps to setting prices that can help you stay competitive and profitable.

1. Use production costs to determine a base price

You have to break even before you can make money, so it's important your prices cover your production costs. Add up the expenses you pay to create your products or services, including overhead costs such as rent and labor, as well as variable costs such as materials and shipping. Divide that total by the number of units you expect to sell, and you'll have an idea of the minimum break-even price.

2. Set a goal for your profit margin

Because you're not in business to just break even, decide on your desired profit margin, or the amount you can keep after production costs. Determine a reasonable profit margin by researching industry standards. View financial data from Butler Consultants on average net profit by industry, or read business publications that report on profit margin trends. In 2014, for example, Forbes reported restaurants have an average net profit of 5.1%,1 and The Fiscal Times reported daycare centers average a 7.5% margin.2 Once you know your industry's average, you can adjust your base price accordingly.

3. Perform a competitive analysis

Your competitors' pricing can also guide you as you adjust your base price and decide on a final figure. Research what they're charging for goods and services similar to yours, and reflect on how you want to competitively position yourself. For example, do your competitors target a more affluent market? Then you might set your prices slightly lower. Or do your products and services have added value? Then you might raise your prices.

4. Research customer spending habits

Before setting a price, know how much customers are willing to pay for your product or service. Gauge spending habits by talking to your customers, sending them surveys, or conducting focus groups. If you discover customers are willing to pay $30 for a product that only costs $10 to create, you might set the retail price well above the minimum price that would cover your production costs.

Choosing the right pricing strategy for your product or service can be challenging, and you may need to adjust. But using your own financial information and analyzing data from your industry, competitors, and customers can help you set prices and earn a healthy profit margin.

 


1 "U.S. Restaurants Seeing Fatter Margins." Forbes. (2014) http://www.forbes.com/sites/sageworks/2014/06/22/us-restaurants-margins/

2 "The Day Care Business Has a Growth Spurt." The Fiscal Times. (2014) http://www.thefiscaltimes.com/Articles/2014/06/20/Day-Care-Business-Has-Growth-Spurt

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