Finding the perfect pricing strategy

One of the most important strategic questions you’ll have to ask yourself as a small business owner is ‘How much should I charge?’ 

Pricing is critical to maximising revenue – as is knowing the right moment to raise or drop prices. How much are your offerings worth? What is a fair price for your product or service? A little economics can help you figure out the ‘right’ price.

Determine your pricing strategy

When setting your own prices and comparing them with your competitors, think about which pricing strategy best suits your products or services:

  • Volume pricing – you pass on savings and earn greater profits by buying and selling in bulk.
  • Cost-plus pricing – take your cost price and add a margin to it, so you can make a profit in line with your sales targets.
  • Competition matching – charge exactly what your closest competitor charges, while differentiating on branding, packaging, or advertising.
  • Milking – set a high price initially, then lower it to make your product or service available to a wider market.

Also consider the psychology of prices within the marketplace. For example, selling a pen for 99c instead of $1.

Take into account Westpac’s merchant service fees, which are payable for all credit card transactions accepted through a merchant facility, when calculating your pricing.

To price high or to price low?

Charging the lowest or highest price in the market isn’t necessarily the best approach. If you charge too low you’ll have smaller margins, won’t maximise revenue, and may be suggesting your products or services are of lesser value.

On the other hand, if you price too high, you’ll allow competitors a chance to undercut you, may have declining sales, and might sell too few units to bring in the highest possible revenue.

Price elasticity

The price elasticity of demand for your goods or services will determine whether you’re better off charging a low or high price. Price elasticity is simply how much more of your offerings your customers demand when prices go down, and how much less they want when prices rise.

You need to know the price elasticity of demand for your products or services to maximise revenues. If demand for your product or service is elastic:

  • Customers are sensitive to a change in price.
  • Increasing your price a little results in a bigger than expected drop in demand.
  • Raising your price will cause total revenue to fall.

For example, products with close substitutes, like chocolate bars, have elastic demand. If the price of one chocolate bar goes up a little, a consumer will choose another brand’s chocolate bar instead.

If demand for your product or service is inelastic:

  • Customers aren’t sensitive to a change in price.
  • Increasing your price may cause demand to fall but overall revenue will rise.

For example, selling a necessity item, like fridges, tends to have inelastic demand. In this case, the price of a fridge would have to increase a lot for a customer to go without one.

Luxuries are much different – people may choose to do without them if prices rise.

Differentiation

A key point to consider when working out your pricing strategy is what your customers think about your brand. Do they see what you offer as different from the competition? If they do, their demand for your product or service will be inelastic. BMW is a good example of a product that’s sufficiently different from its competitors that many customers won’t buy another brand even when prices go up.

Make sure you know who buys your products or services. The type of person who regularly purchases your offerings may or may not be price sensitive.

Understanding price elasticity of demand is crucial for you as the owner of a small business. Knowing your customers’ sensitivity to changes in price will aid you to set prices that will maximise revenue.

Once you’ve determined your pricing strategy, take a look at Westpac’s payment solutions.

Know your place in the market

You’ll have an idea of where you should fit into the current marketplace, depending on whether your products or services are cheap bargains, top-end luxury items or somewhere in between. A little time and research can assist when clarifying where you belong.

It’s important to know exactly what your competitors are charging. Ideally, you’ll have researched how their prices have changed over time and what their customers’ perceptions are of their products or services.

Research your competition

Understand why a competitor may be a lot more expensive yet has a solid customer base. Do they offer extra features, benefits, or excellent post-sale customer service? You need to know:

  • Who offers the best value – and who is perceived to offer the best value?
  • Who’s trading successfully – what do they offer that’s slightly different from the rest?
  • The standard market price – the rate that your goods or services are worth in the marketplace.
  • Your competitive advantage – whether your products or services have a clear point of difference over your competitors.
Keep reviewing your prices

After setting your initial prices, ensure you review your prices frequently to stay consistent with the overall market. Changes in turnover could signal a problem with prices or even an opportunity to capitalise on.

Always check what your industry is doing and possibly renegotiate with suppliers. If you have a similar or higher price than your competitors and your margins are low, your costs may be too high.

Don’t be afraid to raise prices if you believe your target market is price inelastic. Loyal customers will appreciate your service and understand, as long as you explain your reasons up front. At the very least, make sure you keep your prices in line with inflation.

Putting time and effort into planning your business will pay dividends in the long run. There are a couple of related guides you can refer to below.