How to avoid common pricing mistakes

Unless you provide very high priced, custom-to-each-client services, the worst way to price your products or services is a cost-plus pricing. How cost-plus pricing works: You calculate your full costs, including overheads, and set a price where all of those costs are covered and so is the acceptable (to you) amount of profit per sale.

Example: You plan to sell t-shirts, so you add in your direct costs (materials & ink for the logos) of let’s say £14, add in a proportion of your overhead (salaries, rent, etc.) let’s say £8, plus your desired profit of £4 per shirt to arrive at a price of £26.

Cost-plus pricing is not only your worst choice, but it is also the most widely used pricing strategy. That means that when you start pricing more intelligently, you will have a real advantage over most of your competitors!

So, you may ask, if cost-plus pricing covers all my costs and gives me a fixed amount of profit per sale — what’s not to like? There are three key problems with it:

Problem #1:

The price you establish may be so high that you will lose money through lost sales. Consumers buy at a price that seems “right” to them. Can you picture them thinking the following? “Well… this price is much higher than I expected to pay but the seller needs to make this much to cover costs — so I’d better pay it or the seller may lose sales.” I can’t picture it either!

Problem #2:

All cost-plus calculations require an estimate of sales to be accurate. To figure in overhead, you have to apply it to each product sold. For example, if your rent/phone/electricity/assistant costs add up to £100,000/year and you estimate your company will sell 100,000 t-shirts, you apply £1 of your overhead to the price of each t-shirt to cover that cost. But… what happens if you actually sell just 20,000 t-shirts? That means you have £80,000 of costs which you did NOT cover. That means the fixed amount of profit you built into each price has just disappeared. In fact, you have lost money — with a pricing strategy that was supposed to “guarantee” you a profit.

Nobody can do an accurate enough prediction of sales volume to make cost-plus pricing work (except for companies which create a separate bid for each large-priced, custom job). After all, the number of products you can sell will vary widely depending on the price you set.

Problem #3:

Cost-plus pricing can cause you to underprice your products or services — thus cheating your company of sales it could have earned. How? Let’s suppose by some miracle you actually guessed right on the units you would sell. Let’s say you calculated you could sell 100,000 t-shirts, and by using cost-plus pricing you came up to a price of £26 — to cover all your costs and add £4 profit per shirt. Then you sold 100,000. Congratulations? Maybe not. Maybe those consumers who bought at £26 would have been perfectly willing to buy the same shirt at £29. What happened? You just cost the company £300,000! That extra money could have allowed your company to test a new product line… or covered losses from another product… or allowed the owner (you?) to put your kids through university.

What’s your product WORTH to consumers?

That’s the only real basis for setting a price. If you can’t get enough from such a price to be profitable — you shouldn’t be selling the product!

 

How do you calculate the value of something to a consumer?

Start with the price of your nearest competitor’s product. That will be (in the consumer’s mind) a “reference price” what they would expect (all things being equal) to pay for your product. Then add in the value (to the consumer) of the superior benefits and features your product has over your competitor’s. Then subtract the value of your competitor’s features which are superior to yours.

How do you find the value your competitor puts on those additional or missing features? You will learn this and more in the e-book PRICE FOR PROFITS. Sign up  – and download it for free!

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One Comment to "How to avoid common pricing mistakes"

  1. Analyst Jobs says:

    We find that many candidates have the analytical and data/IT/excel skills but not actually always the commercial side. ie. interpretting the data and suggesting / justifying proposals accordingly. This is what many of our clients are looking for i.e. this level of commercial added value. Hope this helps.
    Regards
    UK Pricing Analyst Jobsite

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