When I consult with a start-up business owner, I know the conversation will eventually turn toward pricing. The question they always ask me is: How do I establish my prices?
The question is as old as time itself. Unfortunately, my standard response is not what most aspiring entrepreneurs are looking for. The answer?
While this answer may seem deflating, at least initially, understand that the conversation never ends there. You see, when establishing your pricing there are a number of factors to consider.
Obviously, it has to start with examining your costs in order to determine what your break-even point is. After that, it comes down to a number of other variables:
I will address each of these questions individually.
#1 – Are you a commodity?
If you are a service-based business, you are not a commodity. The market place may try to commoditize your business, but you cannot allow that to happen.
WHY?
Because consumers buy commodities based on price and you do not want your services to be judged solely on price. I would also argue that consumers should not buy commodities based exclusively on price, but I that is a conversation for another day.
I have seen many new businesses struggle because they allowed the market to commoditize their business. Worse yet, I’ve seen business owners do this to themselves. They do a bit of market research, assume everything is an apples to apples comparison, and establish their rates to undercut the competition. DO NOT DO THIS.
You need to value yourself and the services you provide. If you don’t, no one else will.
#2 – Is your business model volume based?
If your business is selling a typical commodity, it is likely volume based. A volume based business is usually transactional in nature. The goal is to keep COGS (Cost of Goods Sold) low, maximize efficiency in operations and distribution, and sell to the masses.
If your business is volume based, price almost certainly will be heavily influenced based on the market. Unless you invest time and energy into educating the market on why your product is better and worth more, you have to be priced competitively in order to maximize market share. It doesn’t mean you have to be the cheapest, but you will need to be comparable with the market averages.
#3 – Are you offering a premium product or service?
The answer to this question is important. When you offer a premium product or service, price becomes less of a factor. You are marketing to a select group of people who value quality and can afford to pay for it.
Because your ideal customer may be the higher income earners, your market is smaller. It will be critical to maintain higher profit margins because your sales totals will typically be much less than volume based businesses.
Businesses offering premium products or services must allocate significant time and resources toward product/service development, quality control, and exceptional customer service. They must also invest in educating the market on what sets their product or service apart, making it superior to what the competition offers.
#4 – How much demand is there for your product or service?
The driving force behind any ecosystem is simple: SUPPLY AND DEMAND.
I know entrepreneurs who have developed some incredible products and services only to find out that there isn’t much of a market for what they are offering.
Conversely, I’ve seen existing businesses shift their efforts to underserved markets simply because the demand outpaced what current providers could supply. They recognized that an opportunity existed, and they pivoted in order to take advantage.
Before you can establish your pricing, you have to determine how big the market is for your respective product or service. Once you know how big the market is and what others in the market are charging for their product or service, you can begin to evaluate what your particular market will bear.
As you work through this process, remember that there aren’t right or wrong answers to any of these questions. You, and your business, have the potential to be unique and as such, you have value within your industry. You should consider your value proposition and how it may set you apart from your competition.
I’ve worked through this process many times and the information I’ve just shared with you is only a small piece of it. If you feel stuck in this area and would like to discuss it further, I’d love to speak with you. You can reach me at kent@kentgustafson.com.
Schedule a one-on-one call with Kent to create a financial plan with lasting impact.
