Fiducial | We help your business grow and be profitable.

by Renee Fellows

April 25, 2008 — You’ve ordered your product, built your online and physical store fronts, ordered a credit card machine with merchant services, and now you’re ready to hit the streets to do some serious product selling. How are you setting your selling price and what are you providing to your vendors as incentive to carry your product? Determining the correct price for your product, one that’s not too high, not too low, but just right, is part skill and part marketing psychology.

The Goldie Locks Method

It’s important to establish the right price point at the very beginning of the marketing process. Goldie Locks had it right when she tried all three of the Bear family’s beds to find the one that was ‘just right’. All of your accounting and financial projections will be based on the product’s suggested manufacturer retail price (SMRP). Set your price too high and it will be ‘hard’ to sell enough of your product. This will leave inventory on hand very high and sales sluggishly slow. Set the price too ‘soft’ and you’ll sell out but you won’t make any profit. Working your way to the magic ‘just right’ number is a matter of truly understanding your business’ financial situation, the competition and what the market will bear.

It’s much easier to reduce a price than it is to face angry retailers and customers if you need to raise it later. That doesn’t mean that you can’t reset your pricing if fuel costs hit $4 per gallon. Consumers will expect those types of increases. All things being equal, they won’t take to kindly to an increase just for the sake of increase without receiving some type of higher perceived value (i.e. is it a bonus pack where you receive two items for the slightly higher price of one?).

Regardless of the type of product you sell, the price you set will determine the success of your business. Let’s review the basic strategies of product pricing:

• Price must cover the costs of production including overhead

• To lower prices, you must lower your costs

• Know the real costs of running your business

• Understand the ‘value proposition’ that your product brings to the market

Competitive Pricing

When there’s an established market with relatively set pricing, competitive pricing or value basis pricing is often your best method. This type of pricing is most often used with commodity markets. For example if you’re selling latex gloves, which often sell for pennies a pair, there are several conglomerate players in the market such as Johnson & Johnson with deep pockets and an even larger distribution system and client base. These market leaders set the price for the entire market and smaller companies are compelled to follow.

There are several strategies to enter a commodity market including under-pricing, price-matching or niche selling. Under-pricing is when you enter the market at a drastically lower price to buy market share in the hopes of then retaining those customers once you re-adjust your pricing to be competitive. This type of ‘market buying’ can only be done for a short period or the company will run out of cash going bankrupt before ever turning a profit. In price-matching, you simply match the competition’s price, but that’s no guarantee that you’ll be able to turn a profit or produce the product as cheaply as they do. If you decide to price-match, but sure that you have a solid understanding of your actual costs and what you will need for a workable profit margin. If you target niche markets for your product, you’ll find more flexibility on pricing but you’ll need to be very vigilant on sales volumes needed to generate the gross margin required to cover your fixed costs.

To take our Goldie Locks analogy a step further, let’s consider that Goldie is on 5 th Avenue in Manhattan looking for a pair of shoes. You have a new shoe store that has recently opened on 5 th Avenue (and carries shoes similar in look to Manolo Blahnik) and you want to attract shoppers like Goldie. How do you set your pricing? Goldie has been eyeing a pair of Manolo Blahnik strappy sandals in Neiman Marcus for months. She knows that the shoes are an extravagant purchase, (Mama Bear has told her repeatedly that Payless is a much better value) but she figures she’s only young once and really deserves to have those shoes. How you price your shoes depends largely on your market and its perception of your product.

Do market research to determine the value of your pricing against that of your competition. This is not to say that your pricing cannot be higher or lower than your competition’s. The important take-away is that once you set your price you must have a logical and persuasive argument for why your product is worth what you’re asking. This is also known as perception or perceived value.

What makes Manolo Blahnik shoes worth $485 a pair versus Payless’ at $29.99? Goldie’s perception, of course (and well, Manolo’s are just prettier). To help Goldie in her decision, give the product the best marketing support you can afford. Be sure that your campaign reflects to the best of your ability your unique selling proposition (USP) and why your product is the best one in the market.

If you elect to set your shoe’s selling price below the market value, you’ll need to reassure Goldie (and your target market) that your shoes are of high quality and fashion. You may also want to have a solid return and product guarantee policy to further assure your resellers and customers. If you are selling a service, it’s a little easier to set your price above your competition’s because you can add ‘value’ with a higher level of customer service (i.e. more client face time or services) and additional warranties.

Setting a Mark-up

Cost-plus pricing, mark-up pricing or full-cost pricing is a financial accounting calculation based upon fixing a gross profit margin that the business requires given the expected sales volume and fixed overhead or operating costs to produce a net profit. Normally a sales price determined by using a cost basis calculation would be the amount paid for the product plus an incremental percentage. The price the market will bear is actually a function of demand. For example, a 50% mark-up may yield a selling price that is considerably less than what the market will support. Those Manolo shoes and niche products often command a price that is far above the set mark-up.

Selling Price = Total Cost x (1 + Mark-Up Percent)

Selling Price = $100.00 x (1+4.85)

Selling Price = $100.00 x (4.85)

Selling Price = $485.00

So, if you want a similar mark-up of 485% (a profit equal to 485% of the total cost) the selling price of those pretty strappy sandals must be set at $485.00. A word of warning, don’t confuse mark-up pricing with profit margins and gross margins. Remember that the profit margin is the dollar value difference in the selling price and total cost. Therefore, the profit margin in the previous example is ($485.00-100.00) or $385.00 per unit, whereas, mark-up is traditionally figured as a percentage of the seller’s cost.

There are numerous factors to take into consideration when calculating the mark-up for your shoes:

• Sales location – you’re competing with Neiman Marcus on 5 th Avenue, so your pricing must naturally be higher than if you were a Payless Shoe Store at the mall.

• Added values – what else, if anything, will your customers get for their expensive purchase. It’s ok to consider prestige, fashion and popularity as factors, just be cautious.

• Buying policy

• Operational fixed costs - (including property, equipment leases, loan repayments, inventory, utilities, financing costs, and salaries/wages/commissions – don’t forget to include markdowns, shortages, damaged goods, employee discounts, cost of goods and profits)

• Variable expenses – telephone, office supplies, printing/packaging, marketing, seasonality, and more importantly changes in supplies and services from vendors. Consider fuel and energy a moving target in the current economy.

• Review your costs frequently so that you don’t have any surprises.

A word of advice – treat profit as a fixed cost. That’s right. If you think of profits as a flexible amount, you’ll never realize a consistent, fair profit. Business size also has an influence on the bottom line as small business accounting is less sophisticated than that of larger companies and there are more financial controls in larger businesses.

Market and economic conditions will also factor into your asking price. In today’s recessionary market a business may need to consider not only what the market will bear but also the types of payment terms distributors and resellers will need in order to carry the inventory. Tight times mean that accounts payable usually stretches organically. Rather than face serious cash flow issues right at product launch, put together varying levels of payment terms that will provide your customers more opportunity for timely payment.

A major part of marketing and sales success depends on having the right priced product at the right time. Depending on Goldie’s checkbook, she may decide that Manolo Blahniks just aren’t an option right now, or she may value the shoes more than she likes to eat (some markets are fickle like that). Study the market, your competition and talk with colleagues in your industry to understand their processes, successes and failures. When in doubt, seek expert advice from advisors in finance accounting and marketing. It will be money well spent when Goldie wears your shoes to the Storybook Awards and makes the cover of Glamour magazine. It may just be enough to boost product sells and allow the profits to begin to tally.

Renee Fellows is the owner of ClearPoint Marketing Communications in Derry, New Hampshire. She works with small business clients to develop marketing and public relations strategies that bring business and customers closer together. She can be reached at 603-434-9433 or via email at Rfellows@oneclearpoint.com.

Whatever your small business needs, your Fiducial tax and financial professional can analyze your situation and recommend an appropriate action plan. To locate a Fiducial office nearest you on fiducial.com, see the Zip Code Locator located in the upper right hand corner of the page. Do you have a particular topic that we should be writing about that can help your business? Please send your suggestions to: Howard.Margolis@Fiducial.com.

DISCLAIMER
Although we do our best to provide our users with useful and accurate information on our web site, we do not update this information which is derived from sources believed to be accurate. Users must understand that information presented does not serve as an endorsement of any particular company or individual and that this information changes frequently and is subject to differing interpretations. Users are hereby advised that they are responsible for ensuring that the facts and general advice obtained from our site are applicable to their specific situations and should discuss their specific tax, business, financial, and legal matters with pertinent professionals.