When Is The Price Right?

During the business downturn of 2001—2002, many businesses of all sizes were forced to cut prices to try to maintain market share and reduce inventory. The challenge is to reduce prices enough to entice buyers without cutting too deeply into profits. This is a big issue with small businesses in particular. They have fewer revenue streams and depend on consumer spending habits.

How do you price effectively? According to Mitchell Gooze, president of Santa Clara, California-based marketing and sales consultancy Customer Manufacturing Group Inc., small businesses typically rely on two strategies: competition and cost. Retailers, for example, mark up based on a standard factor, while manufacturers add overhead and related costs to come up with a set price. Many companies also look at what the competition is charging, then either add or subtract a little to stay in line with those prices. “Overall, companies tend to use these external pricing strategies as opposed to value-pricing strategies simply because it’s easier,” says Gooze.

But easier doesn’t necessarily mean better or more profitable. Jay B. Lipe, president of the Minneapolis-based small business marketing consultancy Emerge Marketing and author of The Marketing Toolkit for Growing Businesses (Chammerson Press; $19.95), says that too many companies adjust pricing without adjusting their level of service accordingly. For example, a hair salon might drop the price of a haircut by $5 to compete with a new low-price salon down the block. But if that same hair salon doesn’t also scale back on its level of service, it could soon find itself in the red.

“If a customer demands a 10% reduction in price, you have to ask them to give something up on their end — like a shorter warranty,” says Lipe. “By doing so, you’re letting that customer know that you’ve offered the best price possible, but that you can negotiate on the additional services.”

In the current economic environment, Lipe says that too many small business owners make desperate moves in an attempt to gain market share without realizing how it can adversely affect their business. “They may get the business, but in the long term, they’re really just shooting themselves in the foot,” says Lipe, who advises companies to first account for all direct (those costs directly related to the delivery of the product or service) and indirect costs (overhead). The latter is particularly important, Lipe says, since companies often factor in direct costs only while overlooking costs such as payroll, electricity, water, and rent.

Once the costs have been determined, put away your calculators and look at your company’s position in the marketplace, then develop a price with your customer in mind. Think Ferrari versus Ford. “Everyone knows that the price of a Ferrari is going to be higher than the average car, but we also know the car is positioned at a higher level of performance than most,” says Lipe. “The key is to ask yourself which of the three tiers (i.e., good, better, or best) you want to be in, and set your prices accordingly.”