# Pricing Strategy
* [How to Do Your Own Market Research](https://www.thebalance.com/do-it-yourself-market-research-2947171)
* [Fixed and Variable Expenses in Business Budgets](https://www.thebalance.com/fixed-and-variable-expenses-in-business-budgets-398512)
* [Reasons Why Gross and Contribution Margins Are Different](https://www.thebalance.com/gross-margin-vs-contribution-margin-393474)
* [Learn About Direct and Indirect Costs in Pricing](https://www.thebalance.com/product-pricing-direct-and-indirect-costs-393470)
* [Definition and Characteristics of an Entrepreneur](https://www.thebalance.com/entrepreneur-what-is-an-entrepreneur-1794303)
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##### [Pricing Methodologies for Business Owners](https://www.thebalance.com/the-new-business-owner-s-guide-to-pricing-strategy-1201235)
* Determining exactly how much to charge for your products or services is a major step towards setting your long-term pricing strategy as a company.
* Before we get to the actual pricing methodologies, here are some of the factors that you need to consider when crafting your pricing strategy:
* **Positioning Your Pricing Strategy**
* If you're running a discount store, you're always going to be trying to keep your prices as low as possible (or at least lower than your competitors).
* If you're positioning your product as an exclusive luxury product, a price that's too low may actually hurt your brand.
* People really do hold strongly to the idea that you get what you pay for.
* **How Your Pricing Strategy Will Affect Demand**
* You're going to have to do some basic market research to find this out, even if it's informal.
* Get 10 people to answer a simple questionnaire, asking them, "Would you buy this product/service at X price? Y price? Z price?"
* **Cost**
* Calculate the fixed and variable costs associated with your product or service.
* How much is the "cost of goods", i.e., a cost associated with each item sold or service delivered, and how much is "fixed overhead", i.e., it doesn't change unless your company changes dramatically in size?
* Remember that your gross margin (price minus cost of goods) has to amply cover your fixed overhead in order for you to turn a profit.
* Many entrepreneurs underestimate the importance of this and it gets them into trouble after choosing to follow the wrong pricing methodology for what their business can actually sustain.
* **Environmental Factors**
* Are there any legal or other constraints on pricing?
* For example, in some cities, towing fees from auto accidents are set at a fixed price by law.
* what possible actions might your competitors take?
* Will too low a price from you trigger a price war?
* Find out what external factors may affect your pricing strategy.
* The next step is to determine your pricing objectives. What are you trying to accomplish with your pricing?
* **Short-Term Profit Maximization as a Pricing Strategy**
* While this sounds great, it may not actually be the optimal approach for long-term profits.
* This approach is common in companies that are bootstrapping, as cash flow is the overriding consideration.
* It's also common among smaller companies hoping to attract venture funding by demonstrating profitability as soon as possible.
* **Short-Term Revenue Maximization as a Pricing Strategy**
* This approach seeks to maximize long-term profits by increasing market share and lowering costs through economy of scale.
* For a well-funded company or a newly public company, revenues are considered more important than profits in building investor confidence.
* Higher revenues at a slim profit, or even a loss, show that the company is building market share and will likely reach profitability.
* Amazon.com, for example, posted record-breaking revenues for several years before ever showing a profit, and its market capitalization reflected the high investor confidence those revenues generated.
* This pricing methodology accurately reflects their overarching mission to become the largest online retailer.
* **Maximize Quantity**
* There are a couple of possible reasons to choose the pricing strategy.
* It may be to focus on reducing long-term costs by achieving economies of scale.
* This pricing methodology might be used by a company well-funded by its founders and other "close" investors.
* Or it may be to maximize market penetration, which is particularly appropriate when you expect to have a lot repeat customers.
* The plan may be to increase profits by reducing costs or to upsell existing customers on higher-profit products down the road.
* **Maximize Profit Margin**
* This pricing strategy is most appropriate when the number of sales is either expected to be very low or sporadic and unpredictable.
* Examples include custom jewelry, art, hand-made automobiles and other luxury items.
* **Differentiation**
* At one extreme, being the low-cost leader is a form of differentiation from the competition.
* At the other end, a high price signals high quality and/or a high level of service.
* Some people really do order lobster just because it's the most expensive thing on the menu, so that can also be a viable pricing strategy.
* **Survival**
* In certain situations, such as a price war, market decline or market saturation, you must temporarily pursue a pricing strategy that will simply cover costs and allow you to continue operations.
* Once you've considered the various factors involved and determined your objectives for your pricing strategy, now you need some way to crunch the actual numbers.
* **Cost-Plus Pricing**
* Set the price at your production cost, including both cost of goods and fixed costs at your current volume, plus a certain profit margin.
* For example, your widgets cost $20 in raw materials and production costs, and at current sales volume (or anticipated initial sales volume), your fixed costs come to $30 per unit. Your total cost is $50 per unit. You decide that you want to operate at a 20 percent markup, so you add $10 (20 percent x $50) to the cost and come up with a price of $60 per unit.
* So long as you have your costs calculated correctly and have accurately predicted your sales volume, you will always be operating at a profit.
* **Target Return Pricing**
* Set your price to achieve a target return-on-investment (ROI).
* For example, let's use the same situation as above, and assume that you have $10,000 invested in the company.
* Your expected sales volume is 1,000 units in the first year.
* You want to recoup all your investment in the first year, so you need to make $10,000 profit on 1,000 units, or $10 profit per unit, giving you again a price of $60 per unit.
* **Value-Based Pricing**
* Price your product based on the value it creates for the customer.
* This is usually the most profitable form of pricing methodology, if you can achieve it.
* The most extreme variation on this is "pay for performance" pricing for services, in which you charge on a variable scale according to the results you achieve.
* **Psychological Pricing**
* Ultimately, you must take into consideration the consumer's perception of your price, factoring in things like:
* **Positioning:** If you want to be the "low-cost leader", you must be priced lower than your competition. If you want to signal high quality, you should probably be priced higher than most of your competition.
* **Popular price points:** There are certain "price points" (specific prices) at which people become much more willing to buy a certain type of product. For example, "under $100" is a popular price point. "Enough under $20 to be under $20 with sales tax" is another popular price point, because it's "one bill" that people commonly carry. Meals under $5 are still a popular price point, as are entree or snack items under $1 (notice how many fast-food places have a $0.99 "value menu"). Dropping your price to a popular price point might mean a lower margin, but more than enough increase in sales to offset it.
* **Fair pricing:** Sometimes it simply doesn't matter what the value of the product is, even if you don't have any direct competition. There is simply a limit to what consumers perceive as "fair". If it's obvious that your product only cost $20 to manufacture, even if it delivered $10,000 in value, you'd have a hard time charging two or three thousand dollars for it -- people would just feel like they were being gouged. A little market testing will help you determine the maximum price consumers will perceive as fair.
* Now, how do you combine all of these calculations to come up with a pricing methodology that works for your business? Here are some basic guidelines:
* **Your price must be enough higher than costs to cover reasonable variations in sales volume.** If your sales forecast is inaccurate, how far off can you be and still be profitable? Ideally, you want to be able to be off by a factor of two or more (your sales are half of your forecast) and still be profitable.
* **You have to make a living.** Have you figured salary for yourself in your costs? If not, your profit has to be enough for you to live on and still have money to reinvest in the company.
* **Your price should almost never be lower than your costs or higher than what most consumers consider "fair".** This may seem obvious, but many entrepreneurs seem to miss this simple concept, either by miscalculating costs or by inadequate market research to determine fair pricing. Simply put, if people won't readily pay enough more than your cost to make you a fair profit, you need to reconsider your business model entirely. How can you cut your costs substantially? Or change your product positioning to justify higher pricing?
* Pricing is a tricky business. You're certainly entitled to make a fair profit on your product, and even a substantial one if you create value for your customers. But remember, something is ultimately worth only what someone is willing to pay for it.
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##### [Pricing Strategies for Small Business](https://www.thebalance.com/pricing-strategies-for-small-business-2951181)
* The pricing strategy of your small business can ultimately determine your fate.
* Small business owners can ensure profitability and longevity by paying close attention to their pricing strategy.
* **Lowest Pricing Does Not Win**
* Having the lowest price is not a strong position for small business.
* It invites customers to see your product or service as a commodity and obscures any value-add you offer.
* Plus, larger competitors with deep pockets and the ability to have lower operating costs will destroy any small business trying to compete on price alone.
* Avoiding the low price strategy starts with looking at the demand in the market by examining three factors:
* (1) **Competitive Analysis:**
* Don't just look at your competitor's pricing. Look at the whole package they offer.
* Are they serving price-conscious consumers or the affluent group?
* What are the value-added services if any?
* How do you compare?
* (2) **Ceiling Price:**
* The ceiling price is the highest price the market will bear.
* Survey experts and customers to determine pricing limits.
* The highest price in the market may not be the ceiling price.
* (3) **Price Elasticity:**
* According to the Harvard Business Review:
* Some products have a much more immediate and dramatic response to price changes, usually because they’re considered nice-to-have or non-essential, or because there are many substitutes available,” explains Avery. Take for example, beef. When the price dramatically increases, demand may go way down because people can easily substitute chicken or pork.
* **Avoiding a Price War**
* Do not get into a price war - odds are you will lose and be left out of business. Take these 4 tips to avoid a deadly price war:
* (1) **Enhance Exclusivity:** Products or services that are exclusive to your business provide protection from falling prices.
* (2) **Drop High Maintenance Goods:** There may be products or services in your business that have high customer service and maintenance costs. Drop the unprofitable lines and find out what customers don't want.
* (3) **Value-added:** Find value your business can add to stand out in the marketplace. Be a unique business in the category.
* (4) **Branding:** Develop your brand name in the market. Brand name businesses can always stand strong in a price war.
* Small businesses with solid pricing strategies can escape a price war and low price position.
* Carefully, consider your price decisions. Your business depends on it.