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The Scientific Way to Determine the Price of Your Products or Service

Pricing your products or services should not be a
one-time event. Underlying costs, customer sentiment
and ability to pay, and pressure from competitors change
regularly, so prices should be monitored regularly to
make sure your offerings are most attractive to buyers
and provide optimal profitability for your company.

by Jeffrey Moses

Prices in direct sales

Direct sales methods offer the perfect opportunity to
determine the best possible price for a product. What
does the "best possible" price mean? Simply put, the
best price is that which results in maximum
profitability. (Profitability means total revenue less
total costs.)

In direct sales, price is a major determinant for the
number of items that will sell when placing a given ad.
When an item costs $9.99, it usually sells better than
when costing $15.99. By running different ads, or by
sending out different mailings with varying price
points in each, you can scientifically determine the
price point that brings in the greatest profit.

For example, say that an item costs you $5. If you set
the price at $10 and sell 100 of the items, your total
revenue will be $10 x 100 items = $1,000, less cost of
$5 x 100 = $500. Total profit: $500.

If you set the price at $7.50 and sell 250 items, your
profit will be $7.50 x 250 items = $1,875, with cost of
$5 x 250 = 1250. Total profit: $625. Thus, lowering the
price yielded greater total profits, even though less
was made on each sale. (Note: the cost of advertising
and shipping the product was not considered in this
basic example.)

By testing different price points, direct sales enables
you to determine, in a scientific way, the price that
yields the greatest actual profit.

Retail sales
It’s normally not possible in retail sales to use
pricing strategies as exacting as those in direct
sales. The same principles exist, but in retail you
can’t charge one price to a certain group of customers
and a completely different price to another. Therefore,
other pricing determinants must be brought into play.

Pricing in retail depends on:

1. Underlying total costs of products or services
2. Competitor prices
3. Consumer sentiments and ability to pay
4. The amount of business you receive from customers

A company cannot remain in business when forced to
charge less than the total underlying costs of its
products or services. Costs directly related to sales
include product cost and sales staff salaries,
advertising and shipping. Other operational costs of
running a business also must be factored into
profitability: utilities, debt service, salaries of
non-sales staff, lease or mortgage costs, insurance and
taxes.

By determining the total cost of operating your
business, you can set a break-even point for your
business. Based on that, you can set prices for your
products, realizing that as in direct sales, higher or
lower price points will yield varying total revenues.

You can then compare your potential prices to the
prices your competitors charge. Clearly, you cannot set
prices without considering your competition. But by
first knowing your underlying cost structure, you can
adjust your prices to be competitive, knowing the
margin you must maintain to assure the desired level of
profitability.

Consumer sentiment and ability to pay are a major
factor in what you can charge. Consumer sentiment
changes often, depending on local, national and global
factors that usually are beyond your control. Consumer
ability to pay can change as the general or local
economic situation varies. Paying close attention to
consumer sentiment and ability to pay can help you keep
prices in line with what customers feel comfortable
paying for an item or service.

A service-based company has a fourth important aspect
to consider when setting prices: the amount of business
it is receiving from customers. When a service company
does not have enough business, its prices usually are
too high. (Other factors such as marketing and quality
of work apply.) You can modulate the amount of business
you get by lowering or raising prices.

Ongoing monitoring of costs, prices, competitiveness
and profitability
Costs of products, operational costs, consumer
sentiment and other factors that determine prices are
not static. They change regularly. By being aware of
these changes, prices can be modulated to maintain
competitiveness and profitability.

Even when your business is functioning smoothly, with
steady profitability, you should regularly review
underlying costs and prices to see if costs can be
reduced and if prices can be raised to increase
profitability or lowered to generate additional sales.
Profitability is a blend of cost, price and amount of
sales. Constantly examine this mix to see if there are
ways to increase profitability.

Since underlying costs are the primary basis for
setting prices, reducing costs is the most effective
and enduring way to be able to lower prices. When a
company can secure lower costs than competitors, it can
gain market share by lowering prices, even while
maintaining or increasing profitability. It’s often
said that every dollar of cost-saving falls all the way
to the bottom line. This is reason for you to
continually examine ways to control and reduce costs.

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