How to set prices for your small business

Your prices decide whether customers will buy your products or those of your competitors. Some customers may even prioritise a low price over a quality product. 

It’s important to keep all these factors in mind when deciding the prices for your products.

In this article, we’ll outline how to set prices for your small business. We’ll also provide you with the details on popular pricing strategies, including:

• Cost-plus pricing
• Competitive pricing
• Penetration pricing
• Value-based pricing
• Price skimming
• Psychology pricing

How to set prices for your small business

The most common pricing mistake that first-time business owners make is to immediately set their prices as low as possible to beat the competition. While this idea has some merit, it’s far from the only pricing strategy out there. 

The prices of your products should have more to do with your own finances than the prices of your competitors. When setting prices, consider factors like manufacturing costs and monthly expenses. Even if you hope to keep your prices very low, you need to ensure that you’re making a profit somewhere. 

As well as examining your own finances, setting effective prices means conducting thorough market research. Find out what your local competitors’ prices are, and how they decide their pricing. 

You should also consider your industry as a whole, and see how cheap or expensive the type of products you sell generally are in the wider market.

See also: what is market research in business?

Different pricing strategies for your business

This strategy requires some calculation. To price items using a cost-plus pricing strategy, you need to add up all the expenses involved in bringing your product to market, then add a profit margin on top of that.

The expenses might include (but aren’t limited to) things like:

• Manufacturing costs
• Courier fees
• Packaging costs 

The profit margin is simply an amount you’ll add on top of the expense total so that the item makes money. Profit margins vary a lot, but most retailers add between 0.5% and 6.5% of the expense total.

Please feel free to try our gross profit margin calculator.

Competitive pricing is similar to the strategy we mentioned before, where you’ll aim to set your prices lower than the prices of your competition.

The secret to using competitive pricing effectively is to continuously monitor competitor prices. They’ll likely adjust their prices frequently — sometimes so that they’re even lower than your prices. 

You need to be aware of these changes so you can react accordingly. 

This is a high-risk high-reward strategy. When using penetration pricing, you’ll sell all your products as cheaply as possible to undercut competitors. 

Then, once you’ve established a customer base through word of mouth and inexpensive products, you’ll raise prices to increase profit margins.

The risk in penetration pricing comes when you raise your prices later. Doing so can potentially cause customers to stop buying from you as they realise the low prices were only temporary.

Luxury brands often use value-based pricing. This strategy revolves around the perceived value of the product, regardless of the manufacturing costs. 

Essentially, you’ll aim to sell your products at significantly higher prices than your competitors to create an air of luxury and exclusivity. 

Value-based pricing only works with quality products, as inflating the prices on poorly made items is unlikely to work. 

You may also need to invest a lot of money in marketing and brand awareness to ensure a value-based pricing strategy works.

Price skimming is common among technology companies or other industries that have enthusiastic early adopters. 

The strategy means setting a high price for the product at first, then lowering prices as consumer interest wanes and competitors enter the market. 

Timing is very important in price skimming. Businesses need to monitor their sales carefully, so that they can maximise the amount of time they can keep products at a higher price point. If you lower the prices  before sales begin to dip, the business will lose out on revenue.

It’s difficult to base your entire strategy on psychology pricing, so it’s best used alongside other strategies to ensure effectiveness. Psychology pricing relies on taking advantage of how customers feel about prices rather than their logic. 

A famous example of psychology pricing is to sell an item for £X.99 instead of the closest round number (i.e. £2.99 instead of £3). Although there’s barely a difference between the two, customers tend to perceive the £X.99 as much cheaper. 

Value-based pricing can also benefit from using this trick in reverse. By using a round number or multiple of ten in the item price, you can communicate a sense of high value.

If you sell a product that requires a consumable component, like razors and razor blades, this might be a good strategy for you. It involves selling the base product cheaply, but adding a considerable profit margin to the consumable element.

Since customers need to buy the consumable to use the base product, they’re tied in to continuously buying replacement consumables. This helps generate revenue for your company in the long run. 

If you find the right price level for your goods, you should notice an increase in your sales revenue. Unfortunately, this also means having to do more financial admin. You can avoid spending hours on bookkeeping tasks by using accounting software like Countingup.

Countingup is the business current account and accounting software in one app. It automates complicated bookkeeping admin for thousands of self-employed people across the UK. 

Start your three-month free trial today.