Pricing Yourself to Get and Stay In Business

Pricing Yourself to Get and Stay In Business

© 2002 Elena Fawkner

It goes without saying that the bottom line of any successful
business is profit. Don’t make a profit and you won’t be in
business for very long.

Making a profit is pretty simple really.

You just have to make more than you spend. The trick is to
know how much you have to make to exceed what you spend.

And you spend more than money when running a business.
You spend something infinitely more valuable. Time. And,
as we all know, time is money.

To maximize profits, accurate pricing is absolutely critical.
Your prices must be high enough to cover costs and enable
you to earn a reasonable return but low enough to remain
attractive to prospective clients.

New entrepreneurs often have difficulty accurately pricing
the value of their time and expertise. Some take the approach
that they can work cheaply because they're fast and they’re
prepared to take any work, now matter how low-paying, to fill
in the time between more lucrative assignments.

For this group, the mindset appears to be that any work is
better than no work. Although this may seem reasonable when
you're first starting out and you just want to make your
mark as early as possible, the downside is that this short-
sighted approach can create in customers a “cheap”
mindset that is difficult to shift once the business becomes
established.

Another group of entrepreneurs, though, takes the approach
from the outset that they are worth top dollar and demand
fair pricing for the value they provide and won’t accept anything
less. This group appears to be more successful than the
former in the longer run. Sure, they may find it slow to start
with. After all, they are new in town, they can't rely on
repeat business and they can't ride the wave of their own
impressive reputations. But by setting the bar high to start
with, when their businesses DO become established, they've
set the tone and their businesses usually have a firmer
foundation for it.

This article looks at the fundamentals of pricing for the new
home-based business entrepreneur.

BASIC PRINCIPLES OF PRICING

Here are some basic principles to keep in mind when
considering your pricing strategies:

=> Prices must at least cover costs.

If you don't at least cover costs, and this includes an
amount for your time, you will incur a loss. If your business
is incurring a loss it's a hobby.

=> The best way to lower price is to lower costs

As price equals costs plus profit margin, it's obviously better
to reduce the cost element than the profit element if, for any
reason, you find that you must reduce your prices.

=> Prices must reflect the environment in which they operate

Any price, whether yours or your competitors', necessarily
reflects the dynamics of cost, demand, market changes,
competition, product utility, product longevity, maintenance
and end use.

=> Prices must be within the range of what customers are
prepared to pay

It's all very well having the best bread slicer in the western
world but if your price is more than customers are prepared
to pay for it, so what? On the other hand, there is absolutely
no reason to charge less than customers are prepared to pay
either.

=> Prices should be set at levels that will shift products
and services and not to beat competitors alone

It's easy when you start delving into all of the sophisticated
analysis and research around about optimum pricing levels
to forget that, at the end of the day, you set your prices as
high as you can while still shifting your products and
services. So don't think that keeping pace with competitors
is enough. It isn't. You may have competitive advantages
that mean you can charge more than your competitor.

=> The price you set should represent a fair return for your
time, talent, risk and investment

Don't be coy about demanding a reward for what you
bring to the table. Your expertise and talent has objective
worth. Don't just give it away. Charge for it.

PRICE = COST + PROFIT MARGIN

The basic price you will strike is simply your costs plus a
profit margin. It follows that before you can set your prices
you must know exactly what your costs are. Costs fall
into three main areas:

=> Direct Costs

Direct costs are those things directly related to the creation
of your product such as raw materials, parts and supplies.

=> Overheads

Overheads are business costs not directly related to
production and include things such as taxes, rent, office
supplies and equipment, business related travel, insurance,
permits, repair of equipment, utilities (electricity and
telephone) and professional advice (accountant, lawyer).

=> Labor

Labor costs include all wages paid to employees *including
yourself*. It's amazing how many home-business owners
forget to include their time as a cost of business!

Calculate your labor costs by multiplying the number of
hours worked by an hourly wage. You should also include
fringe benefits (typically 15% plus).

Once you have ascertained your total costs, add a profit
margin. A 15-20% profit margin is standard for most
home-based businesses. Although you have included
your own wages in your labor costs, if you don’t add a
profit margin there will be no money for growth or expansion
of the business.

RELATIONSHIP BETWEEN PRICES AND PROFITS

The easiest way to increase your profit is to raise your prices.
But you can’t just raise prices indiscriminately. Look for
ways to manipulate niche pricing instead. This means
looking for specific areas of your business where you have
some latitude to increase prices.

The way to do this is to identify the areas where the
perceived value of what you are offering is higher than the
price you are currently charging. Start by carrying out a
competitive analysis of your business. Find out how your
product compares with your competitors’ on the basis not
only of price but costs as well.

If you are going to source this information by approaching
competitors directly, a word of caution ... DON’T. The
Sherman Act in the US (and similar legislation in many
other jurisdictions) prohibits businesses of any size from
entering “contracts, combinations or conspiracies” in restraint
of trade. In other words, it’s illegal to make deals with
competitors about what price you’ll charge or what services
you’ll offer. Merely discussing prices with competitors can
be construed as an attempt to conspire on prices. This is
one area where you just don't want to give even the *whiff*
of an impression of doing anything of the sort.

So, be circumspect in your research. Never discuss prices
with competitors and avoid frequent communications with
them at all if possible. Instead, to keep tabs on what your
competition is up to, read their ads, talk to their suppliers,
engage mystery shoppers or send an employee to make
observations.

Once you have completed your competitive intelligence,
analyze your competitive advantages and disadvantages.
If, as a result of your analysis, you learn than you have
an advantage over your competition because your business
is website design and you know how to do cgi-scripting but
your competition has to outsource this function and this
means a delay of one to two weeks, then this advantage is
something your customers will likely pay more for. Adjust
your prices accordingly.

WHEN YOU'RE THE PRODUCT

Some businesses don’t offer tangible products at all.
Sometimes, YOU are the product. So, how do you price
yourself if you’re, say, an ecommerce consultant and
your business is assisting brick and mortar businesses
make the transition to ecommerce?

One perfectly reasonable approach is to start with a
calculation of your actual expenses and your salary needs
and then divide the total by a reasonable estimate of billable
hours. An article entitled "Setting Fees" by David Dukoff
gives a good overview of how to go about doing this.

Let’s say your expenses and salary needs mean that your
business needs to be generating $100,000 a year. Let’s
also say you prefer to charge clients by the hour rather than
by quoting on projects. How much do you need to charge
per billable hour to generate $100,000 per year?

Dukoff uses the following approach. To start with, how
many billable hours do you have? Let’s start with 2,080
work hours in a year. Deduct 100 hours for vacation time
(2 weeks), a further 80 hours for popular holidays, 40 hours
personal time and sick leave and 20-40% of time for
marketing and administration. This leaves you with around
1,000 billable hours in a year. You therefore need to charge
$100 per billable hour to achieve your goal of $100,000
income.

OTHER PRICING STRATEGIES

Other pricing strategies to include in your structure include
discounts to encourage prompt payment or quantity
purchases, seasonality issues (for example, end of season
“sales”), offering senior citizen and student discounts and
other promotional incentives.

As you can see, setting the "right" price for your products
and services is absolutely crucial to the profitability (read
survival) of your business in the longer term. But with
careful analysis and a methodical approach, you should be
able to arrive at reasonable pricepoints without too much
difficulty. Then it's just a matter of monitoring demand in
response to price changes to settle on the optimum pricing
for your business.

But don't rest there. Your prices operate within a constantly
changing environment and you need to be ever-vigilant to
ensure that your prices remain at their competitive maxima.

One final piece of advice: if in doubt, price high rather than
low. It is much easier to discount prices than it is to increase
them.

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Elena Fawkner is editor of A Home-Based Business Online ...
practical business ideas, opportunities and solutions for the
work-from-home entrepreneur.
http://www.ahbbo.com