In this series, we delve into three pivotal questions for achieving business success, offering practical tools and techniques for SME owners to address them effectively.
Since the dawn of commerce, business owners have grappled with three fundamental questions, even before the advent of AI, the internet, and electricity:
- Who is my ideal customer?
- What makes my product or service attractive?
- How should I price my product or service?
Lessons from The Warehouse’s Struggles
An article in the NZ Herald from June 2024, titled “Big Red: What Went Wrong for The Warehouse,” highlighted the challenges faced by one of New Zealand’s iconic retail brands, The Warehouse.
A senior analyst at Forsyth Barr remarked, “I don’t know if they [The Warehouse] know what they are and how they fit into the New Zealand retail landscape, or what they are going to compete on.”
Greg Smith of Devon Funds Management added, “They need to recalibrate what is the value proposition.” The Warehouse, known for its bargain prices, now faces stiff competition from retailers like Kmart, which influences customer perceptions of what constitutes a bargain.
Relevance to SMEs
Though The Warehouse operates on a large scale in a competitive market, the principles of business success it struggles with are equally relevant to SMEs. Whether you run a global conglomerate or a food truck, understanding your target market, what makes your product or service attractive, and setting appropriate prices are fundamental to success. Once you grasp the first two questions, answering the third becomes significantly easier.
In this article, we will focus on the third question: How should I price my product or service?
Table of Contents
Pricing Your Product or Service
We’ve all heard stories about pricing mistakes leading to unexpected success. For instance, a retail worker mishearing instructions and pricing a clearance product too high, only to sell out quickly. Pricing affects everything from your business finances to your product’s market positioning, whether it’s a timeless, bespoke item or a short-lived trend. It’s a strategic decision, blending art and science.
Initial Pricing Strategies
A common method to determine an initial price is the cost-plus pricing strategy. This involves adding up all the costs involved in bringing your product to market and adding your desired profit margin. This straightforward approach sets a starting price based on production costs and desired profit.
Another approach involves leveraging insights from existing customers to test higher prices. This method helps you gauge whether your market will accept a price increase. However, before setting your product’s price, consider other important factors.
Understanding Your Costs
An effective pricing strategy starts with a thorough understanding of your costs. For ordered products, the cost of goods sold is straightforward. For manufactured products, you must consider raw materials, labor costs, and overhead costs. Calculate the total cost of a bundle of materials and determine how many products you can produce from it to estimate your cost per item.
Don’t overlook the value of your time. Set an hourly rate you aim to earn and divide it by the number of products you can make in that time to include your time cost as a variable cost in your pricing model.
Calculating Your Price
To determine a sustainable price, consider what your target customers are willing to pay consistently. A simple formula for a “back of the envelope” calculation is to divide your total variable costs by 1 minus your desired profit margin (expressed as a decimal). For a 20% profit margin, divide your variable costs by 0.8.
Considering Fixed Costs
Fixed costs, such as rent and salaries, remain constant regardless of sales volume. Ensuring your pricing strategy covers these costs is crucial. Testing different price points helps you understand how your fixed costs fit into your pricing model.
Dynamic Pricing and Market Research
Dynamic pricing adjusts prices based on market demand and competition. Regular market research is vital to stay competitive and responsive to market trends. Understanding your target market and customer base allows you to set prices that reflect market demand and customer expectations.
Practical Steps for SMEs
- Identify Potential Customers: Conduct market research to understand your ideal customer. Analyze demographics, preferences, and purchasing behavior to tailor your products and pricing strategies.
- Define Your Value Proposition: Clearly articulate what makes your product or service attractive. Highlight unique features, benefits, and how it solves customer problems.
- Set Your Prices: Use a combination of cost-plus pricing and market research to determine an initial price. Test higher prices with a segment of your customer base to gauge acceptance.
- Monitor and Adjust: Continuously monitor market trends and customer feedback. Be prepared to adjust your pricing strategy to remain competitive and meet market demand.
Conclusion
Addressing the three fundamental questions of business success—identifying your ideal customer, understanding what makes your product or service attractive, and setting the right price—is essential for any business, regardless of size. If a major company like The Warehouse struggles with these questions, it underscores the importance for SMEs to regularly revisit and refine their strategies.
By employing practical tools and techniques, SMEs can navigate these challenges, set effective pricing strategies, and achieve long-term success in a competitive market. Remember, pricing is not a one-time decision but an ongoing process that requires continuous evaluation and adjustment to align with market dynamics and customer expectations.
