💻 Presentation: How to Approach Pricing as an Entrepreneur.

📝 Reading: Pricing Secrets of Market Shapers, by Dr. Michael H. Morris

Video: Introduction to Pricing

Video: Pricing - Factors to Consider

Video: Making Pricing Decisions

Many small business owners struggle with pricing — and most set their prices too low. You might feel that the only way to get customers is to charge less, or you may be thinking about what you would personally be willing to pay. Or maybe you feel pressure to match competitors in crowded industries like cleaning or lawn care.

But here’s the truth: competing only on price is a losing game. There will always be someone willing to charge less. That race to the bottom cuts your already thin profit margins and puts your business at risk.

A big reason this happens is because many business owners use “cost-plus” pricing — adding up the cost of making the product, adding a small markup, and calling that the final price. It seems logical, but it leads to underpricing for one major reason:

Price is not about your costs — it’s about the value you create.

Different customers value your product or service differently. That’s why companies charge different prices to different customer groups for the exact same product. It’s also why:

• Starbucks can charge $7.50 for a coffee

• McDonald’s charges $1.00

• And why cuts of meat from the same cow have completely different prices

Your goal is to set prices based on the value your customer receives — not simply on what it costs you to make the product.

To help you price correctly and confidently, use the pricing framework here.

A Practical Framework to Help You Set the Right Price

Click here to see this simple framework which helps you think through the key factors that should guide your pricing decisions. It starts with five things every business owner needs to understand before choosing a price:

1. Your Costs (Your Break-Even Point)
   You first need to know what it costs you to produce one product, deliver one service, or complete one job. This tells you the minimum you must charge just to break even — but remember, this is only the starting point.

2. What Your Competitors Charge
   Look at the prices of other businesses offering something similar. Keep in mind that each competitor may offer different features, target different customers, or provide a different level of value. Use this information to understand the price landscape — not to copy it.

3. Market Demand and Customer Value
   This is the most important factor. Think about how much value your customers get from your product or service and how much they’re willing to pay. Different customer groups may be willing to pay very different prices based on how they perceive the value you offer.

4. Your Marketing Strategy
   Your price must match the story you want your business to tell. Are you positioning yourself as the premium option? The best value for money? The quickest? The most personalized? Your price should reinforce that message.

5. Legal Considerations
   While rare for small businesses, be aware that things like price fixing or colluding with competitors are illegal. For most entrepreneurs, legal issues around pricing are minimal.

Putting It All Together

Once you understand these five drivers, you can map out:

• Your break-even price

• The prices charged by low-end, mid-range, and premium competitors

• What different customer groups are willing to pay (value-focused, average, or premium buyers)

This gives you a realistic price range to choose from. Your next step is deciding where within this range you want your business to sit — and making pricing decisions that support your goals, profitability, and value proposition.

Figuring out what price to charge. Pricing is not one decision, but a set of decisions. These decisions include: price objectives, price strategy, price structure, price levels, and price promotions.

Let’s learn more about each in the section below.

What are we using the price of the product or service to accomplish? What performance outcomes is the entrepreneur trying to accomplish with the prices it charges customers? Performance outcomes could range from achieving a particular profit margin or rate of return, conveying a desired image in the marketplace, charging prices that are perceived as fair, pricing to generate the kinds of volumes that will bring down unit costs, and pricing to discourage market entry by potential competitors, among other possible objectives.

What is the theme or guiding direction that guides a firm’s pricing efforts? The strategy provides the glue that holds together all individual pricing decisions. For our entrepreneurs, the key pricing strategy question is where we want to be on the continuum from a premium pricing strategy (charging a price perceived to be high relative to what people generally expect to pay and what they perceived competitors charge) to parity pricing strategy (charging at or near what people expect to pay or perceive direct competitors charge) to a penetration pricing strategy (charging a price perceived to be low relative to what people generally expect to pay and what they perceived competitors charge). It is not about three options, but again, this is a continuum, so one could be just above parity and just below penetration.

Click here to see a diagram to help you learn some considerations about price strategy.

Once you know your price range, the next step is to design the creative structure behind your pricing. This is where you get to be strategic — and even innovative — in how you charge. The goal is to shape your prices in a way that matches how customers buy, what they value, and how your business can earn the most profit.

Your pricing structure determines how prices change based on:

• What you sell (bundled vs. unbundled options)

• Who you sell to (different customer segments)

• When, where, and how much they buy (timing or volume differences)

• How they pay (discounts, payment plans, subscriptions, etc.)

Here are ways you can play with your pricing structure:

• Bundle or unbundle products and services

• Sell the same product at different prices under different brands or packages

• Offer a low base price but make profit from high-margin add-ons

• Charge more during peak times or less during slow periods

• Offer unlimited use for a flat monthly fee

• Use a base price with extra charges after a certain limit

• Set prices for specific groups such as seniors, students, veterans, or loyal customers

• Offer loyalty rewards for frequent buyers

• Charge less for customers who can buy at off-peak times

• Tie prices to customer characteristics (e.g., shoe size, vehicle type, home size)

• Give discounts for early or cash payments

• Offer discounts for buying in larger quantities

• Use trade or functional discounts based on the type of buyer

• Provide payment plans for higher-priced items

• Use trade-in or upgrade programs

A Simple Example

Think about how a car rental company does this. They may charge:

• Higher prices for renters under 25

• Different rates for AARP members or loyalty program members

• Weekday vs. weekend pricing

• Extra fees if you return the car to a different location

• A flat daily rate with unlimited miles or

• A lower daily rate plus a per-mile charge after a set limit

All of these decisions are part of the pricing architecture — and small businesses can use the same creativity to increase sales and profit.

Once you design your pricing structure, you need to decide the specific prices for each product or service you offer. This means choosing the exact dollar amounts and the price gaps between different options or levels.

For example, if you run a rental car business, your daily prices might look like this:

• Full-size: $43/day

• Mid-size: $32/day

• Compact: $25/day

• Sub-compact: $21/day

These price gaps help customers understand the differences between options and make it easier for them to choose.

You can also use “odd pricing” to influence buying behavior — for example, pricing something at $9.95 instead of $10.00. It may seem small, but these tiny differences can make a price feel more attractive and increase sales.

From time to time, you may want to use short-term price promotions to boost sales, attract new customers, or get people to try a product for the first time. These are temporary deals that create urgency and help you stand out without permanently lowering your regular prices.

Some examples you can use in your business include:

• Short-term price cuts (a weekend or holiday discount)

• Cents-off coupons (digital or printed)

• Buy-one-get-one (BOGO) deals

• Rebates that give customers part of their money back later

These promotions are tools you can use strategically—not something you rely on every day.

Example: Pricing Strategy Mia and Melani Crafted

The decision regarding what prices to charge for your products or services should be approached both carefully and creatively. The price you charge not only determines how much profit you make on each item you sell, but it is an important strategic decision. It conveys an image to customers regarding your quality. It reflects how you are trying to position the firm in the minds of those customers. It reflects your brand identity. And most critically, it is a reflection of how much value you are creating for your buyers.

This last point is of special note. Price is a number. So, you are trying to put a number of the amount of value a customer is receiving. When a customer pays $5.50 for a cup of coffee at Starbucks, and $1.00 for what appears to be the same product at McDonald’s, they are indicating that they see that much value in each case. And, in their minds, it is not the exact same product. They perceive more value in the case of Starbucks, and they are willing to pay for it.

We find that one of biggest mistakes made by entrepreneurs in the UPBI program is that they price too low. They might be afraid that if they did not charge a low price, they would not get any sales. Or, they might think that the low price is a source of competitive advantage. Alternatively, they might think that the low price is all the product or service is worth. Advantage does not come from low pricing, because sooner or later someone will charge a lower price than you. Further, if the price is too low, then you are not making enough money to reinvest in your product quality, product features, packaging, customer service, and other factors that create more value for customers and keep you competitive. Advantage comes from being different from your competitors in ways that matter to customers.

Too many entrepreneurs focus exclusively on their costs when setting prices. They try to estimate their cost per product or service sold, add what they think is a reasonable mark-up, and that is the price they charge (and they often leave out the cost of their own labor). This is a flawed approach for many reasons. But the key one is that this approach frequently fails to capture the value you are creating, and what the customer might actually be willing to pay. So, with low prices you are leaving money on the table. Below we will consider a more strategic approach—one that might make you more money.

A Basic Law of Pricing:

When you are considering what price to charge, keep one core principle in mind. It is always easier to lower price than it is to raise price. As a result, you should always err on the side of a higher than a lower price. If you are charging $17 for your product, but sales are very slow, and so you decide to lower price to $13, it is very difficult to subsequently raise price back up when demand conditions are better and you are selling more. If $17 is an appropriate price (it reflects the value that customers perceive and are generally willing to pay for), then when sales are slow it might be better to maintain the list price, but offer discounts, specials, coupons, rebates, or some other creative way of temporarily lowering price. When the discount or special expires, you still have your price at $17.

Start with Your Target Audience:

Pricing decisions begin with a clear sense of the type of customer you are targeting (refer to STEP 19). You cannot make every customer happy, so determine your target audience and cater the price of your product or service to that audience.

Different market segments tend to perceive different amounts of value from the same product. Some are more price sensitive and others are less so. A young person might not perceive the same value in a health insurance policy as would an older person. A business traveler might be willing to pay more for an airplane flight than would a leisure traveler. Someone with more income might be less price sensitive when buying a meal than a person with a lower income.

A Four-by-Four Approach to Pricing

There are four determinants of price and four decisions that must be made about your prices. Hence, we are suggesting a four-by-four approach. The four determinants are costs, competition, customer value, and your overall marketing strategy:

a. Costs – Costs do matter, and you need to cover them. So, trying to estimate what your cost per unit will be is a starting point in pricing. It does not tell you what price to charge, but instead, what the minimum price must be to ensure you are covering costs. A mistake many entrepreneurs make in the early days of their business is that, when estimating their costs, they do not factor in their own labor time. The entrepreneur is usually doing much of the work in making a product or providing a service, especially in the early days of the business. So, factor in how much of your time goes into making a candle or cleaning a house. Even if the hourly rate is lower than what your time is actually worth, factor in some hourly rate.

b. Competition – Take some time to see what competitors are charging for a similar product or service. Consider a higher end, middle range, and lower end competitor so you can see the range in prices being charged and the differences in the quality being provided. You may be offering more value or targeting a different market segment, but competitor prices are an important reference point.

c. Customer value and demand – The most important consideration is customer value perceptions when it comes to your type of product or service. Again, there are multiple market segments and they tend to perceive value differently. So, focus on the value perceptions of the types of customers you are targeting. Value perceptions are driven by a range of factors, including the strength of customer needs, their income, their knowledge of competitors and what they charge, and their previous buying experience. Also look at demand patterns. In general, is demand up or down? Are there peak demand seasons or times of the year? Are there factors in the external environments that are driving people to need more of your type of product or service?

d. Your overall marketing strategy – What is the image you want to project in the marketplace? How are you trying to position your business in the minds of customers? How are you differentiating the business from competitors? These are all elements of your overall marketing strategy. Price is a tool to reflect that strategy. If you are trying to position yourself as the premium quality provider, then go higher. If you are not all that different from your competitors, then charge a price closer to what they charge. If you want to be perceived as the best value for the money, then a lower price is going to be more appropriate.

With these four determinants in mind, you now must make four decisions: your price objectives, price strategy, price structure, and price levels/tactics.

Price objectives are concerned with what you are using the price of your product to accomplish. This could include the amount of profit you need to make per unit sold, the image you are trying to project, or the extent to which you are trying to discourage competitors from entering the market. Keep in mind when setting price objectives, the relationship between volumes and margins (see STEP 16). If you are selling a product or service where volumes are lower (because the market is smaller, or you are customizing the product to the customer’s specifications, or it takes longer to serve one customer (such as with an event planner), then you need higher margins in order to make money, and so you may need to charge a higher price. Similarly, if you are likely to sell a high volume of items in a given week or month, then lower margins are okay, which can mean a lower price. Another example of a price objective comes into play when you are selling multiple products or services. You might be using the price of one product to encourage sales of another product in your product mix.

Price strategy is a decision on where you want to be on the following scale:

Penetration Pricing ——Parity Pricing ——Premium Pricing

Keep in mind that price is perceived in customer’s minds. Penetration pricing involves charging an amount that is perceived to be low relative to what people expect to pay or the prices they are used to seeing for this type or product or service. Parity pricing is charging a price at or near what customers generally expect to pay or perceive is the normal price. Premium pricing involves an amount that people perceive to be high relative to their normal expectations of what the product or service should go for. So, the question become “where on this continuum do you want to be?”. For instance, are you trying to be just above parity, or a little below premium?

Price structure concerns how you might vary your prices by: a) aspect of the product or service; b) type of customer; or c) time and form of payment. This is where the real creativity comes into play when setting prices. Hence, a rental car company charges a base price to rent a compact car, but might also have fees that vary if you rent on a weekend or weekday, or if you are returning the car to the same place you picked it up. A good example of pricing by aspect of the product is “bundling” and “unbundling”. Bundling is where you combine two or more of your products or services and charge a lower price than what the customer would pay for each product or service individually. Insurance companies will charge you a lower combined price if you buy both their auto insurance together with their home insurance. Unbundling is when you charge for individual parts of the whole, such as a restaurant that charges a la carte for a drink, a salad, an entrée, a vegetable, a potato, a roll, and dessert. A gym might have an overall membership fee to use the entire gym facility, and a cheaper membership fee just to use the pool.

Prices can also be varied by type of customer. So, the car company above might have lower prices for government employees, or for senior citizens. An auto repair business might have lower prices for frequent customers, or veterans. An airline will try to find creative ways to charge business travelers more than people traveling for personal or pleasure reasons. Here, you are looking for market segments that differ in how price sensitive they are. Think about a bar that has a ladies night, charging women a lower price than men.

Prices can further be varied based on when the customer pays, how they pay, and how they buy. So, customers who pay early versus at the time of receiving the product or service versus late may be charged different amounts. Customers who pay cash versus credit could be charged differently. Customers who want to pay over time, such as with a layaway might be charged a different price. The price could also vary depending upon whether the customer buys larger or smaller quantities, or whether they buy online versus through a store.

Price levels and tactics is the final and most important decision area. It is driven by the decisions made in the first three areas. Price levels refers to the actual amount you are going to charge each item. An example would be the decision to charge $8.95 per unit. Please note that many prices end in an odd number, in this case .95, rather than .00. While it is not clear that this generates more sales, it is done on the assumption that customers associate $8.95 more with $8.00 than with $9.00. In addition to setting the price level, you may want to include tactics that are called price promotions. Examples of these pricing tactics could include buy one, get one free; or a coupon that gets you 10 percent off; or a deal where every fifth time you come in and buy, you get thirty percent off; or a rebate for $10 offered during the month of June.

Finally, you should also regularly review your prices. Your costs will change over time, and if they are going up, you may or may not be able to pass the increase on to customers in the form of higher prices. It is also important to keep on top of what competitors are doing with their prices not just in your local market, but look online to see what businesses like yours are doing in other parts of the country.

In STEP 14, we examined basic principles when setting your prices. We discussed the five factors that drive your pricing, which included your costs, the competition, customer value and demand, and your overall marketing strategy, and legal considerations. Three of these factors, costs, competition and demand are always changing. For this reason, prices require ongoing adjustment. Further, your overall marketing strategy can evolve as you add products and sell to new market segments. This is another reason to adjust your prices. Let’s look at each of these factors in a bit more detail.

By now you should really have a good feel for how much each of your products or services are costing you. Are you sufficiently covering your expenses? Are your margins on each item falling as the costs of materials or ingredients or parts or inventory go up? Should you at least raise prices as much as your costs are going up? Rather than you swallowing the reduction in profit, customers generally understand the need for you to periodically make reasonable adjustments to prices.

With the competition, now that you are more established in the market and building a customer following, you may be in a place where you can charge a bit more. Customers see the value in your products or services. They may better appreciate how you differ from competitors. Again, they will not typically abandon you based on reasonable adjustments to your prices. Even if competitors are cutting prices, you do not have to respond.

A major consideration is the kinds of new customer segments that may have begun buying your products or using your services. They may not be as price-sensitive as some of your initial customers. Further, your products or services may be getting better. Remember that price is statement of value—the price you charge should reflect the amount of value a customer is receiving. These are reasons to consider raising your prices for some or all of your items.

Many of our entrepreneurs do not have had a clear marketing strategy in place when they start out. However, as the business begins to gain traction, they develop a clearer idea of this strategy. By marketing strategy, we are talking about how you want to be positioned in the minds of customers, and how you are differentiated from competitors (perceived by customers as offering something unique and different). Price is a critical means for reinforcing your market positioning and for reflecting your differentiation. If you’re pricing too low, then you are not positioning your company in the way you want customers to see it. Further, the more clearly you are differentiated in the customers’ minds, the more justification you have for a higher price.

To further examine how the entrepreneurs wants to position their business, let’s consider the diagram below. Here, we are looking at the pricing for a product or service where $75 would be considered an extremely low price, and $180 would be an extremely high price. Based on our costs, we find that the price just to achieve breakeven is a bit higher than the $75 price. With a little research, we find a range of competitor prices, where we consider a lower-end competitor, a mid-range competitor, and a premium quality provider. We also do some research on different market segments, one of which is very price sensitive and expects to pay less (and will settle for less value or quality), one that seeks average value or quality, and one that is insensitive to prices and will pay for superior quality. As an entrepreneur, you might want to create a similar diagram for your business, as it can help clarify where you really want to be in terms of the prices you are charging.

Beyond the prices you set for each of your products or services, another area where you are now ready to spend more time concerns your price structure. This is an area where you can be quite creative in varying the prices customers actually pay without changing your listed prices. Price structure is concerned with three types of tactics:

• Varying prices by aspect of the product or service: Examples might be a rental car company that has a basic daily rate to rent a car, but charges less for a weekend rental than a weekday rental, or a hair salon that has prices for each item, but also sells bundles, where you can combine a hairdo, a manicure and pedicure for a price that is lower than the three combined prices, a painting company that charges less per hour for one story versus multi-story houses, or a gymnasium that has one price to use the entire gym, and a lower price if you just want to use the free weights (this is called unbundling);

• Varying prices by type of customer or market segment: Examples could be a lady’s night at a bar where women pay a reduced price, a bookkeeping and accounting business that has different rates for small businesses versus larger companies, a power washing business that gives first time customers a different price, or any business that charges a lower price for veterans or senior citizens, or fire fighters/police officers/EMTs;

• Varying prices by using discounts and incentives: Examples here could involve giving customers quantity discounts for buying more than a certain number of units of a product, or what are called cash discounts for early payment (or an early bird rate), or functional discounts because the customer performed some function that made it easier for the entrepreneur (e.g., the customer provides the vacuum cleaner, mops, dusters, and cleaning supplies for the cleaning company);

With the price structure, you are combining creativity with insights regarding the nature of your products and the behaviors of customers. Here are a number of creative ways that entrepreneurs can play with the price structure:

• bundling and unbundling products with price

• selling same product under different brand names at different prices

• low base price and sell add-ons at high margin

• pricing differently at low or high peak times

• unlimited use of product or service for a flat fee

• base price and then variable charges once a threshold is reached

• different prices for different market segments

• loyalty schemes for past or heavy users

• price differences for users who can only buy/use at certain periods

• prices tied to customer characteristics, such as size of their foot for shoes or their car for carwashes

• cash discounts

• functional/trade discounts

• time payment schemes

• trade-in/trade-up schemes