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The Art of Setting Your Price (Article)

Setting the price for a product or service can be a challenge. To be successful you must understand many different aspects of your business today, where you want your business to be in the future and what has worked in the past.

I find that most companies I work with don’t follow a systematic process to establish their pricing and it’s this misstep that is often holding their business back from accomplishing optimal success.

The following can serve as checklist to consider when setting your prices:

Start with Your Direct Costs

To properly set your prices, you must identify the direct costs for creating your product or service. While this sounds logical, many business owners I work with are guessing at these costs.

Some questions to answer: How much are the supplies? What do you spend on shipping or procuring raw materials? How much time does it take to service a customer?
Breaking these direct costs down per unit, customer, project or contract is the first and most important step.

Take Into Account ALL of Your Costs

Once you understand your direct costs, you need to look at the other costs for running your business. Covering your overhead and other fixed costs is one of the greatest challenges a growing company faces.

How much is your office space? What about your sales & marketing budget or the technology it takes to run your company? These costs need to be considered as part of your overall price.

Make sure your pricing includes enough margin to cover these overhead costs, but resist the temptation to overcharge a few customers for items that will be easily covered once you are running at full steam and can spread them across multiple sales.

Ignore Your Competition

There are many of the same products and services that are different prices. Setting your price “because it is what your competitor charges” is a bad model. It is important to know what your competitor is charging, but only so you can explain why your prices are more or less.

If your customer understands why they should buy from you, the price will not be a significant factor in their decision process. Being cheaper doesn’t mean you will win your customer’s business and a savvy customer will be suspect if your pricing is too low.

Cover Your Opportunity Costs

Opportunity costs are important to consider when you think about giving a customer a “deal”. Once you assign resources to a project or a contract for less than what you would normally charge, you have lost the opportunity to use those resources in a more profitable way.

If your company provides a product or service that is specialized and not needed on a regular basis, the opportunity cost of having that resource available should be factored into your pricing.

My company provides research services to other companies and they pay a premium for the specialized skillset and training my staff receives. The amount they pay is far less than what it would cost to have those resources on staff full time.

Evaluate Prior Projects

The easiest way to set and understand your pricing is to evaluate prior projects. I insist that each project delivered and contract fulfilled is revisited to understand the actual profitability. It’s in this exercise of looking at what was charged versus what it cost that many lessons are learned, processes can be improved and evidence can be shared to support better pricing in the future.