SmartCompany spoke to two leading finance experts for their top tips on how to develop a top-notch pricing strategy.
1. Have a holistic approach to pricing
Jan Barned, principal of Financial Management Trainer, has given many talks and presentations on how SMEs can set their prices and manage cash flow effectively.
“One of the key issues is to get the pricing right and a lot of them [SMEs] struggle with it because they often look at one aspect,” she told SmartCompany.
“So they may look at either how much it costs them to produce their product or service or how much their competitors are offering or what the customer is prepared to pay. In actual fact it should be all three of those plus anything to do in terms of hidden costs.”
John Manning, the founder and managing director of PricingProphets, agrees that small business operators need to consider the bigger picture.
“Customers care about value not cost,” he says.
“While they [business owners] can talk about value, the actual customer may value something completely different to what they think their value is.”
2. Know your customers
Manning says it is crucial to understand your customers. That way, if you need to change your prices, you’ll be one step ahead and anticipate how they will react.
He says knowing what the customer wants allows you to give them tailored choices, which means rather than choosing whether or not to use your services they are more likely to consider which pricing model they should go for.
This could include, for example, a subscription-based model or a pay-per-use system.
“The basic number in pricing is three – always give the customer three choices,” he says.
“Two options forces them to make a price-based decision. With three, they have to make a value-based decision rather than a price-based decision: ‘Which one do I purchase’ rather than ‘Do I purchase at all?’”
Barned says understanding your customer’s “buying behaviours” is critical.
“You need to be aware of your customer wants and why they’re purchasing from you,” she says. “Build a loyalty that is centred around the service you provide rather than the price.”
She uses the example of good coffee: if your customers are after good coffee, and you provide that service but lift the price by 20 cents, they are going to come back rather than choose a poorly made coffee from another outlet.
3. Recognise your prices aren’t set in stone
“You really have to focus on the fact it’s not set and forget,” Barned says with a laugh.
“Pricing is part of the marketing mix. You’re continually changing your marketing, therefore you need to review your pricing on a regular basis.”
Manning says SMEs not changing their pricing model when they should is one of the leading factors behind why so many businesses fail.
“You should be looking at your pricing constantly,” he says.
“New pricing models are emerging and the dynamic companies are staying on top of these. They are realising you don’t have to offer one pricing model.”
Manning says it is important to change your prices to reflect the context they appear in. For example, people are more likely to pay a higher price for a craft beer at an expensive hotel, but would expect it to be cheaper at a small pub around the corner.
“The standard bearer on this is Apple,” he says.
“Apple have done a brilliant job of creating brilliant products and sensitising customers to the value they provide and desensitise them to the price. They’ve created that context with their branding – the trendiness of their products and the fact it works and is reliable.”
Manning says GAP is a good example – the brand’s clothing is matched with polished concrete floors. Meanwhile, it’s cheaper, sister company Old Navy offers less glitz and glam in exchange for cheaper clothes.
“The whole environment in the GAP store is around supporting the pricing strategy for their products,” Manning says.
He points out that a simple way for SMEs to do this is to decide whether or not to round off their prices. $59 suggests a bargain, whereas $60 suggests quality and reliability.
4. Factor in hidden costs
Barned says one of the biggest mistakes SMEs make is to not factor in hidden costs that can creep up and eat into their profit margins.
“If you’re holding stock for a durational period or it is stock that doesn’t turn over regularly, it’s got additional costs [for the business],” she says.
“If you’re holding plates in the refrigerator areas… the costs of electricity and fridges is all going into the cost of that product. Therefore it’s got to be built into the price.”
Barned says too often she sees business jumping to compete with a similar business before considering these behind-the-scenes costs.
“You need to understand how they’re pricing their offer before you go with what they’re going with.”
Hidden costs are also a significant issue for freelancers and sole operators.
“They need to take into account what sort of annual wage or salary they want to earn and non-chargeable days. Because obviously you’re not going to be working 40 hours flat a week on chargeable hours because you’ve got to do your marketing… take that into account as well.”
Manning says he has seen a shift away from charging by the hour.
“There’s a lot of people out there that set an hourly rate based on their expectations around how many hours they want to work and what their costs are,” he says.
“When setting an hourly rate, don’t confuse budgeting with pricing.”