Knowledge Base - Best Practices

5 Critical C’s of Pricing

Source: Finance Bulletin from Scale Finance

What is the best price for your products or services? It isn’t based on how many customers you have, how many salespeople you employ, the standards in your industry — or even what you’ve charged in the past.

The best price is the amount customers will pay that effectively earns your company the maximum profit. It might be significantly higher than what you’re charging now.

To help determine your optimum price tag, here are five critical Cs of pricing:

1. Cost. This is the most obvious component of pricing decisions. You obviously cannot begin to price effectively until you know your cost structure inside out. That includes both direct costs and fully loaded costs, such as overhead, trade discounts and so on.

And it means knowing those cost structures for each item or service you sell – not just on a company-wide or product-line basis. Too often, managers make pricing decisions based on average cost of goods, when in fact, huge margin variations exist from item to item.

Traditionally, businesses have priced their goods and services based on their costs. But cost is often irrelevant in the buying decision of the purchasers. They never even know the cost. Understanding this basic, yet all important principle, is essential to determining the real profit opportunities in your business.

Your company’s gross margin potential is illustrated using the following model:

Potential sales = Units sold X customer’s perceived value per unit

Less cost of sales = Accurate direct and indirect costs of products/ services sold

Gross margin potential = Dollars left to pay all other expenses and generate profits

2. Customers. The ultimate judge of whether your price delivers a superior value is the customer. Are your customers willing to pay more than you’re charging? The information you need to know is:

What is your customer’s expected range — the highest and lowest price points?
Within that range, what is your customer’s acceptable range – the highest or lowest he or she is willing to pay?
When you consider pricing strategy, ask your clientele for their input. Two simple questions: What do you think this product or service is worth? Would you have bought it at another price?

3. Channels of distribution. If you sell through “middle men” to get to the end-users of your products or services, those intermediaries affect your prices because you have to make their margins large enough to motivate them. You must also consider the expenses that intermediaries add. Make sure these third parties add value to the relationship between you and your customers.

4. Competition. This is where managers often make fatal pricing decisions. Every company and every product has competition. Even if your products or services are unique, make sure that you think carefully about your competitors from the buyer’s point of view (the only opinion that matters). If you’re not sure about how your customers evaluate you in terms of alternatives, pick up the phone and ask a few.

5. Compatibility. Pricing is not a stand-alone decision. It must work in concert with everything else you’re trying to achieve. Do you believe a fast-food hamburger chain can sell $10 filet mignons? Is your pricing approach compatible with your marketing objectives? With your sales goals? With the image you want to project?

Those objectives have to be explicitly stated. For example, let’s say your production goal is to even out the process so you can better control inventory. The last thing you want is a pricing strategy that forces seasonal spikes in demand that result in stocking problems.

Before making a final decision on what to charge for your products and services, examine these five critical Cs of pricing. With the right price, you’ll generate enough fuel to power your business.