Mastering pricing practices can be difficult for entrepreneurs

One of the most difficult tasks an entrepreneur has is pricing products, which requires experience and experimentation.

Set prices too high and revenues fall. Set them too low and though revenues increase, profits plummet.

I was at a large flea market in South Florida early one Sunday morning and was carefully watching vendors at various booths. Every so often, a customer would come in, look at a product and make an offer below the listed price. Certain vendors would turn down the offer outright, and the customer would walk away. Other vendors, however, took a different approach: They would answer the low-ball price with a counteroffer, which typically led to a deal.

The first set of vendors thought they were preserving their profit margin by not negotiating on price, while the other set was willing to give up some of that margin to make the sale.

In both cases, there was very little chance of repeat business.

The lesson: If you are selling a homogeneous product with little chance of repeat business, anything negotiated above your cost is gravy. That said, every entrepreneur wants to get as much as possible without losing the customer.

We were helping a woman who owns a catering business that had not been doing well financially. When we started talking about pricing, she said she takes her food cost and doubles it to determine the price she will charge. However, most restaurants want food costs to be less than 30 percent of the price charged. This entrepreneur was charging $200 for an event that cost her $100 in food when, according to industry standards, she should have been charging more than $300.

Once I gave her the formula to determine the appropriate price (food cost times 3.2), her revenue fell by about 10 percent, but her profits rose and she made more money than before in a six-month period.

There are three general pricing methods:

• With the first, take all costs and add an amount for overhead and profits to determine price – a “cost plus” approach.
• A second method is to evaluate what competitors are charging and set prices accordingly.
• A third is to consider perceived value, which is the value customers assign to products and services.

As a general rule, your prices shouldn’t be the highest or the lowest in the market. Just higher than the average price for a similar product is probably a good place to be since consumers typically see a higher price as an indicator of greater value.

The objective is to land on a price that is fair for customers but also capable of earning the maximum profit possible. Finding this optimal figure takes constant tinkering and continual monitoring.

In addition to making sure prices are appropriate, monitor them constantly to ensure they remain at the optimal level for business success.

This story was originally published July 6, 2017 at 12:45 PM with the headline "Mastering pricing practices can be difficult for entrepreneurs."