It goes
without saying that the bottom line of any
successful business is profit. Don’t make a
profit and you won’t be in business for very long.
Making a profit is pretty simple really.
You just have to make more than you spend. The
trick is to know how much you have to make to exceed
what you spend. And you spend more than money when
running a business. You spend something infinitely
more valuable. Time. And, as we all
know, time is money.
To maximize profits,
accurate pricing is absolutely critical. Your prices
must be high enough to cover costs and enable you to
earn a reasonable return but low enough to remain
attractive to prospective clients.
New entrepreneurs
often have difficulty accurately pricing the value
of their time and expertise. Some take the
approach that they can work cheaply because they are
fast and they’re prepared to take any work, now
matter how low-paying, to fill in the time between
more lucrative assignments. For this group,
the mindset appears to be that any work is better
than no work. Although this may seem
reasonable when you're first starting out and you
just want to make your mark as early as possible,
the downside is that this short-
sighted approach can create in customers a
“cheap” mindset that is difficult to shift once
the business becomes established.
Another group of
entrepreneurs, though, takes the approach from the
outset that they are worth top dollar and demand
fair pricing for the value they provide and won’t
accept anything less. This group appears to be
more successful than the former in the longer run.
Sure, they may find it slow to start with.
After all, they are new in town, they can't rely on
repeat business and they can't ride the wave of
their own impressive reputations. But by
setting the bar high to start with, when their
businesses DO become established, they've set the
tone and their businesses usually have a firmer
foundation for it.
This article looks
at the fundamentals of pricing for the new
home-based business entrepreneur.
BASIC
PRINCIPLES OF PRICING
Here are some basic
principles to keep in mind when considering your
pricing strategies:
=>
Prices must at least cover costs.
If you don't at
least cover costs, and this includes an amount for
your time, you will incur a loss. If your
business is incurring a loss it's a hobby.
=> The
best way to lower price is to lower costs
As price equals
costs plus profit margin, it's obviously better to
reduce the cost element than the profit element if,
for any reason, you find that you must reduce your
prices.
=> Prices
must reflect the environment in which they operate
Any price, whether
yours or your competitors', necessarily reflects the
dynamics of cost, demand, market changes,
competition, product utility, product longevity,
maintenance
and end use.
=> Prices
must be within the range of what customers are
prepared to pay
It's all very well
having the best bread slicer in the western world
but if your price is more than customers are
prepared to pay for it, so what? On the other
hand, there is absolutely
no reason to charge less than customers are prepared
to pay either.
=> Prices
should be set at levels that will shift products
and services and not to beat competitors
alone
It's easy when you
start delving into all of the sophisticated analysis
and research around about optimum pricing levels to
forget that, at the end of the day, you set your
prices as
high as you can while still shifting your products
and services. So don't think that keeping pace
with competitors is enough. It isn't.
You may have competitive advantages
that mean you can price higher than your competitor
and still charge more.
=> The
price you set should represent a fair return for
your
time, talent, risk and investment
Don't be coy about
demanding a reward for what you bring to the table.
Your expertise and talent has objective worth.
Don't just give it away. Charge for it.
PRICE = COST
+ PROFIT MARGIN
The basic price you
will strike is simply your costs plus a profit
margin. It follows that before you can set
your prices you must know exactly what your costs
are. Costs fall into three main areas:
=> Direct
Costs
Direct costs are
those things directly related to the creation of
your product such as raw materials, parts and
supplies.
=>
Overheads
Overheads are
business costs not directly related to production
and include things such as taxes, rent, office
supplies and equipment, business related travel,
insurance, permits, repair of equipment, utilities
(electricity and telephone) and professional advice
(accountant, lawyer).
=> Labor
Labor costs include
all wages paid to employees *including yourself*.
It's amazing how many home-business owners forget to
include their time as a cost of business!
Calculate your labor
costs by multiplying the number of hours worked by
an hourly wage. You should also include fringe
benefits (typically 15% plus).
Once you have
ascertained your total costs, add a profit margin.
A 15-20% profit margin is standard for most
home-based businesses. Although you have
included your own wages in your labor costs, if you
don’t add a profit margin there will be no money
for growth or expansion of the business.
RELATIONSHIP
BETWEEN PRICES AND PROFITS
The easiest way to
increase your profit is to raise your prices. But
you can’t just raise prices indiscriminately.
Look for ways to manipulate niche pricing instead.
This means looking for specific areas of your
business where you have some latitude to increase
prices.
The way to do this
is to identify the areas where the perceived value
of what you are offering is higher than the price
you are currently charging. Start by carrying
out a competitive analysis of your business.
Find out how your product compares with your
competitors’ on the basis not only of price but
costs as well.
If you are going to
source this information by approaching competitors
directly, a word of caution ... DON’T. The
Sherman Act in the US (and similar legislation in
many other jurisdictions) prohibits businesses of
any size from entering “contracts, combinations or
conspiracies” in restraint of trade. In
other words, it’s illegal to make deals with
competitors about what price you’ll charge or what
services you’ll offer. Merely discussing
prices with competitors can be construed as an
attempt to conspire on prices. This is one
area where you just don't want to give even the
*whiff* of an impression of doing anything of the
sort.
So, be circumspect
in your research. Never discuss prices with
competitors and avoid frequent communications with
them at all if possible. Instead, to keep tabs
on what your
competition is up to, read their ads, talk to their
suppliers, engage mystery shoppers or send an
employee to make observations.
Once you have
completed your competitive intelligence, analyze
your competitive advantages and disadvantages. If,
as a result of your analysis, you learn than you
have an advantage over your competition because your
business is website design and you know how to do
cgi-scripting but your competition has to outsource
this function and this means a delay of one to two
weeks, then this advantage is something your
customers will likely pay more for. Adjust
your prices accordingly.
WHEN YOU'RE
THE PRODUCT
Some businesses
don’t offer tangible products at all. Sometimes,
YOU are the product. So, how do you price
yourself if you’re, say, an ecommerce consultant
and your business is assisting brick and mortar
businesses make the transition to ecommerce?
One perfectly
reasonable approach is to start with a calculation
of your actual expenses and your salary needs and
then divide the total by a reasonable estimate of
billable hours. An article entitled
"Setting Fees" by David Dukoff gives a
good overview of how to go about doing this.
(To read the article in its entirety, visit http://www.smartbiz.com.)
Let’s say your
expenses and salary needs mean that your business
needs to be generating $100,000 a year.
Let’s also say you prefer to charge clients by the
hour rather than
by quoting on projects. How much do you need
to charge per billable hour to generate $100,000 per
year?
Dukoff uses the
following approach. To start with, how many
billable hours do you have? Let’s start with
2,080 work hours in a year. Deduct 100 hours
for vacation time (2 weeks), a further 80 hours for
popular holidays, 40 hours personal time and sick
leave and 20-40% of time for marketing and
administration. This leaves you with around
1,000 billable hours in a year. You therefore
need to charge $100 per billable hour to achieve
your goal of $100,000
income.
OTHER
PRICING STRATEGIES
Other pricing
strategies to include in your structure include
discounts to encourage prompt payment or quantity
purchases, seasonality issues (for example, end of
season “sales”), offering senior citizen and
student discounts and other promotional incentives.
As you can see,
setting the "right" price for your
products and services is absolutely crucial to the
profitability (read survival) of your business in
the longer term. But with careful analysis and
a methodical approach, you should be able to arrive
at reasonable pricepoints without too much
difficulty. Then it's just a matter of
monitoring demand in response to price changes to
settle on the optimum pricing for your business.
But don't rest there. Your prices operate
within a constantly changing environment and you
need to be ever-vigilant to ensure that your prices
remain at their competitive maxima. One final
piece of advice: if in doubt,
price high rather than low. It is much easier
to discount prices than it is to increase them.
_______________________
Elena Fawkner is
editor of A Home-Based Business Online ... practical
ideas, resources and strategies for your home-based
or online business. http://www.ahbbo.com |
