Learn how to set prices that cover your costs, attract customers, and keep your business profitable.
Setting prices for your products or services is a balancing act between covering costs, staying competitive, and ensuring profitability. While pricing strategies vary based on industry and market demand, understanding the basics — such as cost analysis, competitor pricing, and perceived value — can help you make informed decisions. Here’s what to keep in mind as you’re naming your price.
Learn to master pricing by understanding key strategies that lead to cost recovery, customer attraction, and sustained profitability.
Staying Competitive
Before we dig into pricing considerations, remember that pricing is fluid. You can change your prices and should keep informed about your competition, what your customers are willing to pay, and what you can afford to sustain your business. If you haven’t already, do some preliminary market analysis to identify your core customers and competitors.
Remember to look at peer small businesses and not just large corporate entities. That’s because larger companies sometimes offer “loss-lead” products or services that can skew your findings. Loss-leads are when a company takes a loss on a product or service to attract new customers with the hope of upgrading them down the line.
To keep your small business profitable, you’ll want to set prices that cover costs and are competitive in the marketplace. Sometimes the perceived value of your product or service can drive the price up beyond what your competitors have set, but in general, pricing should be a byproduct of market dynamics and your desired profit margins.
Know Your Costs
The single biggest driver of your price is your cost to provide the product or service. Be aware of the various expenses that feed into your business, and include them in your final price. When determining your final price, include direct expenses like your cost of goods and materials, as well as indirect expenses like time and office costs. (Sound familiar? These costs should also be documented in your Profit and Loss statement.) Be sure to consider:
- Raw Materials: The expenses incurred in procuring the raw materials necessary for your product form the foundation of your cost structure. Fluctuations in raw material prices can directly affect your profitability. For instance, small businesses relying on imported goods have faced challenges due to tariffs and trade policies leading to price surges.
- Taxes and Fees: Understanding your tax obligations plays an important role in setting the correct price. This includes your federal, state, and local taxes, as well as any industry-specific fees. The Internal Revenue Service (IRS) is the best source of information on small business tax responsibilities and considerations.
- Shipping and Distribution: The costs associated with delivering your product to customers — including packaging, transportation, and handling — must be factored into your pricing. These expenses can vary based on factors such as distance, shipping method, and fuel prices.
- Overhead: Overhead costs are ongoing expenses not directly tied to production but necessary for operations. These include rent, utilities, salaries, and administrative expenses. Allocating a portion of these costs to each product or service ensures that your pricing covers all aspects of your business operations.
Pricing Strategies
Now that you know the costs driving your price, it’s time to pick a pricing strategy. There are numerous ways to calculate a final price, but some require additional market analysis and research. Many public libraries offer access to online databases free of charge where you can find market analysis information, particularly by industry. (Librarians are also trained to provide help in querying databases.) For an extensive overview of mathematical formulas used in various pricing models, check out the University of Maine’s pricing toolkit.
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Strategies for Pricing |
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Cost-Plus Pricing: This is the most straightforward method and involves adding a markup to your total costs to ensure a profit margin. For example, if producing an item costs $50 and you’d like a 20% profit margin, you would add $10 (20% of $50) to the cost, setting your final price at $60 to ensure a profit. Value-Based Pricing: This strategy sets prices based on the perceived value to the customer rather than solely on production costs. It requires understanding your target market and the benefits your product or service offers. If customers believe your offering provides significant value, they may be willing to pay a premium price. Competitive Pricing: Analyzing your competitors' pricing can inform your strategy. Setting your prices lower may attract price-sensitive customers, while higher prices can position your brand as premium. It's essential to ensure that your pricing reflects your brand positioning and covers your costs. Penetration Pricing: To enter a competitive market, you might set lower prices initially to attract customers and gain market share. Once established, prices can be gradually increased. This approach requires careful consideration to ensure it doesn't lead to unsustainable losses. Skimming Pricing: This involves setting high prices initially to target customers willing to pay a premium, then gradually lowering prices to attract a broader audience. It's often used for innovative or unique products with little initial competition. |
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External Factors
External factors may influence your pricing or prompt you to revise your prices. Staying current with your competition, market demand, and the larger economic landscape can help you decide when and if to change your prices. Economic conditions like unemployment, inflation, and consumer demand will influence how price-sensitive your customers are. A wide range of laws and regulations can influence your price. Minimum wage laws, environmental regulations, and import restrictions can mean changes to your price, too.
Alternatives to Price Increases
If you’re looking to drive revenues without increasing your prices, think about ways you can increase customer volume. Our team calls this the “airline approach”; rather than fly more airplanes and drive up costs, airlines decreased the space between seats and increased the number of passengers a plane could carry. Beverage manufacturers often reduce bottle or can size rather than increase costs; the consumer pays the same amount but receives fewer fluid ounces, and there are fewer raw materials for the container. Service providers may take a 60-minute service down to a 50-minute offering in order to see an additional client each day. Some service providers will see multiple clients in a single slot. Find the right alternatives for your business, and don’t be afraid to get creative!
Is the Price Right?
To know if you’ve selected the right pricing, start by speaking with your customers. Feedback and surveys can keep you in-the-know about how your customers feel about your price. Analyze your sales data and keep a watchful eye on your competitors. For an outside opinion, Small Business Development Centers (SBDCs) offer counseling and additional guidance on how to boost profits and review pricing.
Pricing is never set in stone, and the most successful businesses regularly evaluate and adjust their strategies. By staying informed on costs, customer expectations, and market conditions, you can keep your pricing both competitive and sustainable.
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