Deciding what to charge can be a huge decision for a new business. Over-charge and you risk alienating potential customers. Under-charge and you may not be able to meet demand.
On top of this dilemma is the knowledge that your choice will be scrutinised – and not necessarily just by customers.
When calculating what to charge, consider a recent warning from the Australian Competition and Consumer Commission, which will investigate businesses misleadingly claiming that price hikes are the result of the carbon price.
The warning was prompted by the discovery that a solar panel business was blaming jacked-up prices on the impact of the carbon price.
Dr Michael Schaper, acting chairman at the ACCC, says price rise claims must be truthful and have a reasonable basis.
“Businesses must be careful in relying on unverified statements by third parties, including those made in newspaper articles and advertisements about the impact of the carbon price, as a basis for their claims,” Schaper says.
The common approach
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But when it comes to price-setting, the majority of Australian businesses use extremely crude strategies.
In fact, 75% of companies use ‘cost plus mark-up pricing’, a method which often results in under-charging and missing margins, or overcharging and missing the sale, according to the experts.
Ron Wood, director of Pricing Insight, a firm which specialises in price optimisation strategies, says that less than 20% of Australian companies have a dedicated pricing management function to drive margin improvement across their business.
“And yet if companies implement a more strategic approach to pricing, it would generate on average between 15% and 100% improvements on profit,” Wood says.
PricingProphets founder and managing director Jon Manning agrees that most companies set their price by calculating their costs, add on a desired profit margin and cross their fingers and hope for the best.
Some also check the price of a competitor’s product (which may not, in fact, be identical to their own product) and charge what the competitor charges.
Or they may just charge what they think the customer will bear, he says.
“Both of these approaches are, in effect, outsourcing pricing to their competitors or customers, leave money on the table and ignore demand and value,” Manning says.
And more often than not, the pricing strategies deployed by start-ups aren’t going to work, according to Julia Bickerstaff, founder of Sydney’s The Business Bakery, which works with SMEs on price-setting strategies.
“Start-ups often start selling their goods or services cheaply, with a plan to increase the price incrementally, but this is a bad approach,” she says.
“You’re far better off setting a fair price up front so you’re not turning people off who have heard about you from friends and wonder why they’re being asked to pay so much more than their friends had to.”
Never set out to be the cheapest in the market, because then you’ve always got to be the cheapest, which can be impossible given the costs involved in running a small business, Bickerstaff advises.
The best approach
A pricing methodology known as ‘value pricing’ is the best approach to price setting, according to Wood.
To implement value-based pricing, consider what the real economic benefits are of your offering to the target market.
This can involve analysing how the product or service will be used by both the immediate buyer and final end user, he says.
In many cases, business people charged with setting prices limit their profit opportunities by being anchored to the cost of production, which serve to drive prices much lower than would otherwise be the case.
Businesses should also create their own pricing tools that enable quick and accurate calculation of quotes, discounts and rebates, Wood says.
“Many businesses take too long to get back to customers, by which stage the customer has already purchased from a competitor, possibly at a much higher price than might have otherwise been the case,” he says.
“Buyers who have an urgent need for a price are often the most price-insensitive as they need it now”.
Dr Greg Chapman, author of a book on pricing called Price: How you can charge more without losing sales, says he has seen countless examples of businesses with unprofitable operations caused by poor calculations made during the price-setting process.
“So many businesses argue that they can’t put up their prices because they will lose money, but in many cases, they’re losing money now,” he says.
“Once a business overcomes the psychological barriers, it can earn significantly more.”
A solid marketing strategy must be in place when prices are being increased, he says.
“You need to be able to clearly communicate your point of difference in your marketing. You need to communicate whether your product saves customers time, lasts longer or is better quality so the market can see why you’re charging the prices that you are.”
“And you need to communicate those messages to the part of the market to which these differences matter.”