One of the biggest challenges for a small-business owner is knowing what to charge for their products or for their services. A nationwide survey of small business executives conducted by INC. magazine showed that:
c 50 percent determined their prices by adding a set percentage to the cost of each product;
c 40 percent set their prices according to what the competition was charging;
c percent used their “gut instinct.”
So, which one is the right way or best way? Or is it a mixture of all three? Let’s take a closer look at product pricing in a retail business.
The cost: For most businesses, the cost of an item is essentially determined by how much it cost to acquire the item and get it delivered to your store — the cost of goods sold — plus some amount of the overhead costs to run the store.
A good example is the store owner who sets her prices by marking up all of her items by 33 percent — say 10 percent to cover wages, 6 percent for rent, 4 percent for advertising, 3 percent for expenses and 10 percent for profit.
If she has done her calculations correctly, all she needs to do is sell enough items at a 10 percent profit to cover her total costs, and everything over that is pure profit. Right?
Well, only if nothing else changes — like delivery increases because gas is more expensive, or changes in supplier charges, or maybe bank charges on the line of credit to take advantage of a quantity discount offered by a supplier. And not all items in a store have the same overhead costs. Take, for instance, refrigerated items, which cost more for utilities than shelf items. Bulk-packaged goods can have lower labor costs than smaller individual units — think a bag of potatoes rather than hand-stacking loose ones.
The lesson: Not all items have the same cost, or determining the true cost is very difficult.
The competition: As the survey shows, many business owners set their prices upon what the other guys are charging, thinking that if they fail to meet the price, they will lose the sale. Competing on price alone is dangerous territory unless it is the only difference between you and the other sellers, you are better at controlling your costs than the others, or you have the resources to outlast the competition in a low-margin contest.
Now competing on price is not a bad strategy, but there is much more to the decision, especially if you only compete on a few but not all of the items you offer.
The customer: As obvious as it would seem, a sale only occurs when someone actually pays you money for an item. Some items won’t be bought no matter how low the price. And, in other situations, people are willing to pay far more than your fixed cost markup price for an item.
The things that motivate buyers beyond the actual price include:
1. Perceived value: “I always buy brand-name products rather than generics.”
2. Prior buying habits: “I do all of my shopping at XYZ store.”
3. Convenience: “I’ll pay more to get the item I want today, rather than wait until tomorrow and get it for less.”
4. Loyalty: “The staff always remember me, and their prices are fair.”
Setting your prices and, yes, changing your prices is both a science (knowing the facts in a changing and competitive environment) and an art (knowing when, how and by how much to adjust your prices to reflect buyer needs and behaviors).
Kurt Corbin is assistant state director of the Hawaii Small Business Development Center, a University of Hawaii at Hilo program that is funded in part by a grant from the U.S. Small Business Administration. This column is published every other Monday. Email questions or comments to editorialstaff@hisbdc.org.
