Pricing is an essential decision for business success. Price too high and you risk losing sales to your competitors. Price too low and profitability may suffer. For an established business seeking growth, a regular pricing review can help to determine the right balance.
Your pricing should take into consideration your business costs, what your competitors charge, what people are willing to pay, and reflect the value of your offering from a customer perspective.
It’s a delicate balancing act. Here are some things to keep in mind when deciding on your pricing strategy.
Calculate or check your fixed and variable costs
Your business must cover its costs to earn a profit. In order to price accurately, start by figuring out your costs or checking them again if you’ve been in business for some time.
Your costs should be organized into two categories:
- Fixed costs – expenses you must pay no matter how much or how little you sell e.g., hydro, internet service
- Variable costs – expenses that rise as sales increase e.g, shipping, labour
The price you set must be higher than the variable cost of producing your product or service. Each sale will make a contribution towards covering your fixed costs and contribute to your profit.
Run pricing scenarios
Now that you’ve calculated fixed and variable costs, you can figure out the best pricing scenario for your product or service.
A snowmobile dealership in Manitoba has variable costs of $9,000 for each snowmobile sold (including paying the manufacturer, compensating salespeople and doing pre-sale maintenance).
The dealership has fixed costs of $200,000 a year that must be covered. If the dealership sells 100 snowmobiles a year, it needs a contribution toward the fixed costs of $2,000 per snowmobile to avoid a loss.
Impact of pricing strategies using the example
The owner of the snowmobile dealerships can elect any of these pricing scenarios.
- Sell below cost - if the dealership sells snowmobiles for less than $9,000 (the variable cost per product), it will lose money on each sale and the business will not cover its fixed costs at all
- Sell at cost - if the dealership sells 100 snowmobiles at $9,000 to cover variable costs, it will suffer a loss of $200,000 as fixed costs are not covered
- Break-even - selling snowmobiles at $11,000 means the dealership will break-even because it’s covering variable and fixed costs. (100 sales will contribute $200,000 to cover fixed costs
- Price for profit - selling snowmobiles at $12,000 will generate a profit for the dealership – assuming it meets the sales target of 100 units (100 contributions at $3,000 will total $300,000 including $100,000 of profit)
Understand the difference between cost and value
There are other factors to consider when setting your pricing including:
- The cost of your product or service is the amount of money you spend to produce it
- The price you charge is your compensation for providing the product or service
- The value is determined by the benefits your customer realizes from your product or service (as defined by them)
Here’s an example of how value can affect the pricing equation:
A marketing consultant must charge $100 an hour to cover his fixed costs. It costs him $20 in variable costs to drive to a client’s office to conduct a one-hour consultation (including fuel and parking). And he charges for travel time – in this case, a 30-minute round trip. But the client is thrilled with the consultant because the advice received will save the client several thousands of dollars. So, the consultant decides to charge the client $250 for the session, far more than the $170 he needs to break-even on the session.
Your pricing should reflect the value of the benefits that your business provides for its customers, while also reflecting the prices your competitors charge. Take the time to understand what your customers’ value from your business. You may be pleasantly surprised and feel you can charge more.
Legal requirements for competitive pricing
Be sure to check that your sales pricing policies fall within the legal requirements set out by the Competition Bureau in Canada.
Before you take action on any of the information above, we recommend consulting with a qualified business advisor that understands your unique needs and situation for your specific business and/or personal plans.