Small business owner setting prices for their products

The Complete Guide to Small Business Pricing 

10+ min read • Jan 03, 2020 • Grant Olsen

Small business pricing can sound deceptively simple, as though it’s one final item on your checklist before your product or service hits the market. Don’t fall into this trap. Pricing strategy is intrinsically tied to the lifeblood of your business. Price products and services wisely, and you’ll set yourself up for sustained success. Miss the mark, and every aspect of your business could suffer. 

As with most things in life, good pricing requires balance, which means you should eschew the worn-out mantra that you should always have the lowest price in the market. This one-size-beats-all approach has its place but will severely undercut your success in many situations.

Again, good pricing requires balance. Your competitors’ pricing is relevant to the equation, but so are all the factors occurring within your own walls.

“Whether you’re launching a new product line or a new business, developing a pricing strategy is an essential first step,” explains a Forbes analysis of pricing strategy. “To do this, you’ll need to consider many factors, from the time and energy it takes to develop your product or perform your service, to your local market’s price points. You don’t want to underprice your offerings, but you also don’t want to price yourself too high and lose out to your more affordable competitors.”

It’s been proven again and again that the lowest price is rarely the best price. Sure, it will catch the eye of budget shoppers. But a bargain barrel price also conveys the feeling that the product or service comes from a barrel. It makes the value solely about price, rather than focusing on the unique benefits you provide. 

When you race to the bottom of the pricing scale, you do more than commoditize your product or service. You also make yourself susceptible to a pricing war. These battles don’t end well for most small businesses, as larger competitors with lower operating costs can beat you almost every time. 

“Avoid getting caught in the trap of comparing yourself to others with similar services,” says Forbes. “Forget them. Really analyze what you do best and ask a generous price for it. It’s OK and actually better if not everyone goes for it. You only need a select few who appreciate what you offer and are happy to pay for it.”

Getting the Lay of the Land

To ask a generous price for what you do best, you need to understand the market. This strategy is best accomplished through a competitive analysis. To get pricing information for your competitors’ products, try using a comparison tool such as PriceGrabber or PriceBlink. These tools allow you to see how much products cost from an array of websites and brick-and-mortar stores. Once you’ve homed in on how much your competitors are charging, you’ll then need to research how they’re positioning their product. Are they going for bargain shoppers or premium shoppers? What value-adds do they claim?

When researching prices for services, go straight to your competitors’ websites to get a better idea of their strategy. You can also use Google or other search engines to get a broader idea of the going rate for your services. As with product research, take note of how your competitors position themselves. This information will help you identify ways to differentiate yourself.

All this research you’ll be conducting in your office is critical to successful pricing, but it also puts you at risk of operating in an echo chamber. Try as you might, it isn’t easy to put yourself in the shoes of a consumer. Objectivity is tough to come by when you’re emotionally attached to and financially invested in your products or services.

To avoid this issue, don’t just try to imagine what it’s like to be a consumer. Talk to one! Start with rapid surveys to your email list with cost-effective services such as SurveyMonkey. Then seek more in-depth feedback from a broader audience by partnering with a service like GutCheck. Any effort you put into understanding your potential customers will be rewarded.

One of the most important aspects of your consumer survey is asking how much they would be willing to pay for your offerings. This price is called a ceiling price and helps you identify the pricing range you need to work with. You’ll often discover that the highest priced product or service currently available on the market doesn’t represent the actual ceiling price. Sometimes there is room in the market for a higher price. There’s also the chance that the highest-priced option has exceeded the ceiling and placed itself above the will of the people. If that’s the case, it will struggle to survive.

You’ll also want to ask questions in your survey that uncover what value consumers see in the products or services they currently use. Their feedback will be invaluable when applied to your pricing strategy and can help you position yourself effectively in the market.

Choosing Your Pricing Strategy

Armed with data gleaned from your competitive analysis and consumer surveys, you’re ready to choose your strategy. Your price will need to be attractive to consumers and also convey the value you offer. Achieving this balance requires you to keep a couple of factors in mind:

  • Availability: How easy is it for consumers to find a product or service like yours? If the market is already flooded, you’ll likely need to take a long look at the ceiling price and then move below it. When demand is high, your price can go up accordingly. In slower seasons, your price will need to go down to attract less motivated shoppers.
  • Cost: In the words of legendary military strategist Sun Tzu, “He who wishes to fight must first count the cost.” When going on the offensive with your product or service, heed this advice. Think beyond the obvious costs, as you also need to account for aspects such as storage, shipping materials, order prep, fulfillment, or marketing. If you leave these ancillary costs out of the equation, they’ll cut into the profit you’ve envisioned.

With all costs considered, you can create a budget for your product or service. This approach helps you look beyond the short term and consider how your pricing strategy will play out in the coming years.

“Look at the bigger long-term picture,” recommends Nionila Ivanova, a product guru from IT Creative Labs. “How many sales will you have to make to sustain your business for a year, for 3 years? Will it be possible to maintain that pricing strategy in a year and 3-year run? What might impact it?”

This broader view helps you to earn a profit while also meeting the needs of your consumers. Most importantly, it empowers you to make that happen sustainably. 

Now you’re ready to choose the best pricing model for your product or service. Here are 7 top contenders worth considering:

  1. Cost-Plus: As the name implies, this model involves totaling the costs associated with selling the product or service, then adding a “plus.” Your total costs represent where you’ll break even on sales, so add the desired profit identified in your budget for the right markup. This approach requires you to have a firm understanding of your costs. Also, you’ll need to position your product or service effectively so that consumers understand the unique benefits.
  2. Lowest-Price: As mentioned earlier, this method is one of the most basic approaches to pricing. After your competitive analysis reveals the current lowest price, you’ll just need to place your price below that. Being the lowest in the market, you’ll definitely catch consumers’ eyes. One problem with this model is that small businesses typically have higher operating costs and can’t afford to get into a price war with larger competitors. Also, when you make your product or service cheap, it takes excellent marketing and positioning to convince consumers that it isn’t actually cheap.
  3. Value-Based: Your consumer research really comes into play with this model. Remember how your surveys revealed the ceiling price for your product or service? Based on that information, you can set a price that stays a bit below the ceiling but still expands your gross margins. Although most small businesses would love to use this model, it’s only relevant if you know the maximum you can charge and position your product or service in a way that illuminates the value associated with the higher price tag.
  4. Pay-What-You-Want: Here’s a risky approach that has gained more acceptance in modern times. Rather than set the price yourself, you allow consumers to decide what they want to pay. Yes, it’s scary. But it can work in the right situations. If there’s an emotional element to your product or service, such as a socially conscious campaign, this approach can be successful. Otherwise, chances are good that consumers will leverage the cost-saving potential of the model and decimate your gross margins.
  5. Dynamic: The market is constantly evolving, so perhaps your pricing should as well. This model requires a firm grasp on the market because changing a price without a good reason probably won’t yield positive results. To improve your success, pay attention to demand and competitive pricing. You’ll need to stay close to the data and react quickly. Otherwise, you’ll be altering the price for your consumers without tying the change to relevant factors.
  6. Price Discrimination: This model also involves flexible pricing, but customer segments determine the amounts. For example, you might set lower prices for your most loyal customers or higher prices for more affluent parts of the country. If you’re strategic with this model, you can meet the needs of various customer segments and boost your bottom line. Done poorly, it can generate backlash from consumers.
  7. Tiered Pricing: While price discrimination allows you to set different prices for various customer segments, this model puts the choice in the consumers’ hands. You create segments within the pricing structure for your product or service, then let customers decide if they want to purchase the high, medium, or low option.

Pricing Case Studies Worth Studying

Every pricing model presents benefits and challenges. What matters is that you understand all the reasons for choosing the various options and then decide which is the best fit for your particular situation.

The following case studies offer a quick snapshot of how other companies have approached pricing for their products or services. Some of the pricing attempts were successful, while others failed miserably. 

Value-Based Coffee

Starbucks uses a value-based approach to identify the ceiling price for its different drinks. Based on their research, they’ve raised prices on certain drinks in specific areas of the country, underscoring the precision required for success with this model. Starbucks can’t compete price-wise with cheaper competitors like Dunkin’, and they inevitably lose some budget-minded customers. To compensate, they carefully raise prices where they know they can get away with this without hurting sales. 

Tiered Pricing Breathes Life into Insurance

After years of battling rivals for the best deals on insurance, Allstate shifted gears. They surveyed consumers to find out what mattered most to them, then launched Your Choice Auto, with options ranging from a Value plan to a Gold plan. This empowering approach spurred millions of policy sales right out of the gate. Better yet, that success has proven to be sustainable.

Value-Based Car Without the Value

In the history of product launches, few have fizzled like Ford’s Edsel in the late 1950s. The car had its share of nice features, but the price tag was higher than consumers felt comfortable with. If Ford had done better research, they would’ve identified the ceiling price and then been careful not to exceed it. Instead, the overpriced car generated a $350 million loss for Ford, and the Edsel earned a spot in the pricing hall of shame.

Pay What You Want for Music

When rock band Radiohead released their 2007 album, “In Rainbows,” they used a pay-what-you-want model. More than 60% of consumers downloaded the music for free, but the band still made more money than they would’ve with a traditional release. Why? Because Radiohead offered the downloads directly from their website, eliminating middlemen such as record companies and iTunes. They made enough money from the 38% of consumers who paid for the album to score a hefty profit and make the gamble a success. 

Tiered Pricing can be Amusing

Six Flags amusement parks have faced stiff competition in the past couple of decades, especially from the Disney juggernaut. They boosted sales by creating a tiered pricing model for their Flash Passes (regular, gold, or platinum). The more expensive the pass, the shorter the amount of time you’ll need to wait in line for rides. The plan worked because Six Flags identified the ceiling price and ensured the passes delivered value for the price.

In the words of one Six Flags executive, “It’s amazing, actually, how many people pay for this.”

Tiered Pricing Sinks the Ship

While it’s true that many consumers are attracted to lowest-tier options, you still need to make sure you’re delivering value. History has shown you can’t strip all that’s good from something and then offer it for a bargain price. Town Sports International learned this the hard way when they offered a barebones membership option that wasn’t worth the paper their fliers were printed on. Revenues plummeted and the CEO resigned a short time later.

Making Sure the Price Is Right

Whether you aim for the lowest price or try to position your product or service near the ceiling, research and careful consideration must guide these decisions. The irony is that many businesses focus on customer needs when creating a product or service then disregard those customers when they’re figuring out the pricing. The closer you stay to the hearts and minds of your customers, the betters your odds for success.

To get a fresh spin on things, seek insights from throughout your company. Talking to a sales representative or warehouse manager can provide perspectives that you can’t get anywhere else. This kind of all-hands-on-deck approach also helps your team feel like they have a voice, which increases their confidence and morale. 

Perhaps you’re worried that you’ll choose the wrong pricing model. That’s a legitimate concern, but it’s worth noting that you can always make adjustments as necessary. 

“Start low and raise prices over time,” advises Forbes. “Always have a competitive pricing structure. You can always raise your prices in the future, but you never want to show clients you need to lower your prices. Also, if you do a promotional price to get customers in the door, make sure the promo scales them back to your regular pricing over time.”

By keeping a holistic view of your pricing and always seeking data from your employees, industry, and consumers, you’ll put your product or service on track for success. There’s no silver bullet for pricing, just a variety of approaches that offer different pros and cons.

Ultimately, every effort you put into getting your pricing right is well spent. As the adage goes, “It pays to think about pricing.”

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Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.