Pricing Right

The last time you were on an airplane, you were likely sitting near someone who paid twice as much as you did for a ticket. You were probably just as close to someone who paid only half your fare. Airlines have complicated algorithms for pricing their seat: business travelers are willing to pay more on short notice, while leisure travelers plan ahead and deal with travel restrictions to pay much less.

Small business owners don't have the luxury of complicated pricing algorithms to determine how much to charge for their goods and services. Accounting for such factors as competition, costs and customers can prove tricky when running a small business.

While pricing below the competition might seem like a great way to drive sales, it may actually create the opposite effect. When you cut prices, it decreases your profit margin. Invariably, your competition will slash their price to catch up, effectively trapping you with your lower margins. This can be especially difficult if you are up against a larger chain store or businesses that are more diversified than yours. Instead, consider offering (and marketing) low-cost ancillary benefits that might allow you to price above the competition: better service, exclusive branding, or a personal touch.

Of course, costs need to be accounted for when setting prices. Be sure not to exclude overhead, labor, and the cost of goods in your calculations. You wouldn't want to lose money for selling an item.

In some businesses, other pricing techniques can lead to maximized profits. Think about how the following examples might apply to your business:

Volume discounts. At a stationery store, one pen might sell for $2.00, while a box of ten could sell for $18. While the per-unit profit margin is reduced by 10% in the box set, the net profit can jump by much more than that due to volume.

Price floors. If you want your restaurant to attract the type of customers that spend $25 on an entrée, you might not want to price the least expensive meal below $20. Of course, you'd better hire a great chef if you hope to sustain those prices.

Two-part pricing structure. In this structure there is an initial fixed charge, and a variable charge going forward. For example, look at ink-jet printers - the machines themselves can cost less than $150, but the ink refills cost $50, and you need to keep buying them forever.

Peak load pricing. As demand for your product rises, you could consider charging more (e.g., if you're leasing out a beach house on Cape Cod, you can certainly charge a lot more for a summer monthly rental than a winter one.)

• Meet Norman Weiss, M.D., a psychiatrist in private practice, who discusses how he takes a sensitive approach to pricing his services. Click on your preferred video format in the 'Watch the Video' area on the right.
  
  
• Access articles on top six pricing mistakes, tactics to avoid lowering your prices, bidding basics, and effective competitive analysis.
  
  
• Find out E. James Burton's answer to the question, "I am planning to start a computer consulting business. How do I determine a price for my services?"
  
  
• Read a profile of Sho Dozono, President of Pacific Gateway, a Portland, OR-based air consolidator.