Pricing Methods for Small Business

Which Pricing Method is Right for Your Products or Services?

On this page you will find a discussion of two pricing methods commonly used by small business to set the prices for their products.

Cost Plus Pricing

Cost plus pricing is a fairly simple way to set your prices.

Basically you determine the product level cost for each of your products, allocate a portion of your fixed costs, and add a profit margin to determine your price.

Allocating your fixed costs can be a little tricky as you need to have developed a reasonable estimate of your activity volume or you risk over or under recovering your fixed costs in your product costs.

The profit margin is the amount (usually calculated on a percentage basis) that you want to recover over and above your costs. Although the norm is between 10 - 30% some small businesses can get away with adding a much higher profit margin. Generally these businesses have lower volumes and the items they sell are in a higher price range.

For most small businesses the product level cos plus fixed costs is the 'bottom line' when it comes to pricing their products. If they decide to price below this level has to be for a very good reason and only for a small number of their products for short period of time, as it is not sustainable in the short or the long term. (Loss leaders, sale items etc).

Market Pricing

Market pricing is where you match the prices being offered by the competitors in your market.

Variations on Market Pricing

The most common variation on market pricing is discounting, where the price is reduced from the market level by a certain percentage to create a competitive advantage.

This strategy does not always work, as in a very competitive market your competitors are likely to price match to reduce or eliminate the advantage.

Quite often you will find that as they are established businesses, your competitors will be able to maintain the lower prices for as long as it takes to shut you out of the market. If you do decide to use discounting as an ongoing marketing strategy, be sure that you have considered all of the possible consequences before you begin a price war that you cannot win!

Some new businesses offer discounted prices during their startup phase as an introductory offer with the intention of raising their prices once they have established a client base.

This can be a reasonable strategy but there are risks. If your new clients are price sensitive, you might find that you loose them once you increase your prices. You might also find that you have unintentionally created an image as a low cost provider in your industry that will be very difficult to change!

What's Next?

By now, if you have been following the structure of this section of the site, you should have:

• Estimated the operating costs for your small business,
• Estimated your product costs, and
• Now you have the information you need to select a pricing method to set your prices.

Congratulations, you are ready to evaluate the profit potential of your business model using break-even analysis!

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