Of all the challenges you face when starting or running your own business, setting prices is among the most important.
Your prices say much about the value you attach to your business and the things it sells. Get your prices right and you create a platform for success. But get it wrong and the implications for your sales, cash flow and profitability can be severe.
To paraphrase first century BC writer Publilius Syrus, everything is only worth what someone will pay for it
What are “optimal prices”?
Set your prices too high and you’ll put off potential customers (to paraphrase first century BC writer Publilius Syrus, everything is only worth what someone will pay for it).
Setting your prices too low can also put people off, if it creates incorrect perceptions about the value you’re offering. They might even pay your competitors more if they believe they’ll get better value. Even if customers aren’t put off, your business will make less profit.
Your aim should be to set optimal prices. These enable you to maximise your profit margins, while keeping your prices attractive. In essence, the challenge is to find a pricing “sweetspot”.
Small businesses (especially newer ones) are often guilty of setting their prices low as a fail-safe way to make sales
Why do businesses get their prices wrong?
Low prices are more common a problem than high prices. And small businesses (especially newer ones) are often guilty of setting their prices low as a fail-safe way to make sales. Then, because they fear losing customers, owners are reluctant to increase their prices. But, that’s just not sustainable.
The danger is that you end up working long hours just to stay afloat. In the worst cases, you can lose money on sales. Competing solely on price is a risky strategy. Competitors might deliberately undercut you to force you out of business.
Value is more important than price. It’s not necessarily what your customers pay – it’s what value they get in return that really matters. If customers get better value from you, charging them more that competitors is justifiable. And most customers will happily pay more for better value where quality matters.
You must know what your customers want and how much they’ll pay for it, as well as how much your competitors charge
When setting prices, you must know what your customers want and how much they’ll pay for it, as well as how much your competitors charge. If you don’t know the answers to these key questions your prices can be way out. While having unrealistic expectations is usually responsible for high prices, at least you can later offer deals and discounts.
How can you tell if your prices are too low?
Setting low prices can mean you end up working very long, grueling hours with little to show for it. Just getting by or struggling to cope can tell you you’re too cheap. Maybe your competitors are doing much better than you?
Sometimes the customers you attract reflect the prices you charge, and punters focused purely on price can be the most demanding customers. Your accountant may be able to help you find out if your prices are too low, either by researching your market or assess your costs.
Get into the habit of reviewing your prices regularly (at least every quarter) – never consider your prices permanently fixed
Get into the habit of reviewing your prices regularly (at least every quarter) – never consider your prices permanently fixed. When your costs increase, reasonable customers will understand price increases (although you could lose them if they can get better value elsewhere).
Setting prices is both a science and art. The more you do it, the better your price-setting skills can get. If you haven’t reconsidered your prices for a while – it’s probably high time you did. Your business depends on it.
• This blog was written for and originally published by KPMG.