There are many factors to consider when setting prices. It’s a bit like heating a bowl of soup. You want it hot, but not too hot to burn your mouth. And if it’s not hot enough, it just isn’t appetizing at all. The goal is to hit the sweet spot that maximizes profits. Since there’s a tradeoff between sales price and volume, it’s possible to vary the price and still maximize profits. Pricing flexibility depends heavily on your ability to meet the demand, so you have to make sure that all the pieces fit together like a puzzle.

Branding
The turnover in retail stores over the years has been enormous, with big chains like Woolworth’s and Montgomery Ward virtually disappearing from the landscape. New retailers have emerged to replace them, and the most successful have been those that established a unique brand awareness.

Walmart’s strategy of everyday low prices has worked because it built its entire reputation and business model around it. It’s not trying to compete with Tiffany, and its customers know exactly what they’re getting when they walk in the store. Anyone starting a new business would benefit greatly from the same clear and concise vision championed by Sam Walton in 1962.

Part of the branding process and philosophy is identifying and capitalizing on your business niche. Your prices should be aligned with the strategy underlying the foundation for your overall business model. How you want your brand to be perceived and accepted plays a major role in how you formulate your pricing tactics.

Psychology
Psychology is a huge component in driving sales and should never be discounted. Many people equate price with quality and sometimes there’s a direct correlation between the two. Experience tells us that’s not always the case. You have to know and understand the customer base you’re trying to reach and how they react to different pricing methodologies. If you’re targeting people who correlate price with quality and you’re offering a high-quality product, then price it accordingly. Just remember that their expectations will be high and you need to meet them.

There are many classes of products where it’s very difficult to discern differences in quality, but the products have a wide range in prices. Is a $25 bottle of shampoo really five times better than another brand selling for $5? Lots of people think so, even though an analysis of the ingredients may reveal that they’re practically identical. One of the reasons high-end retail stores charge more for their products is that customers expect it. That knowledge is factored into every pricing decision they make.

There’s a reason why items are marked $9.99 instead of $10.00. We all know what it is, yet the technique almost always works. While Benjamin Franklin is often credited with the phrase “A penny saved is a penny earned,” the point is well taken whether he said it or not. It’s a fact that even a small difference in price can affect a potential buyer simply because of the way the numbers look. On the other hand, rounded numbers imply higher quality and impart an unwillingness to negotiate.

The trick is to price your products in a way that conveys both quality and value, and also drives sales. That’s far more art than science and requires a thorough understanding of your prospective customer base and competition.

Baseline
The first step in setting prices is to determine your total production cost, including overhead. Add a reasonable profit and this is the baseline price needed to break even. Many small business owners don’t pay themselves a salary at the beginning in order to keep costs and prices down, theoretically driving more sales by undercutting the competition. The problem with this approach is that your customers will get used to paying prices that are artificially low, making it more difficult to raise prices later on.

The important point is to understand your baseline and keep track of it as your business progresses and grows. If your baseline is trending higher relative to the rate of inflation, that’s a signal that you should be scrubbing your costs to make sure you’re getting the best deals possible.

Strategy
Around the world, pricing strategies are heavily dependent on local customs and culture. What works in China may not work in the United States, and vice versa. In the USA, most strategies boil down to three basic approaches: economy, value and premium pricing.

Economy pricing depends on heavy sales volume to offset small margins. Your branding and marketing are designed to promote your business as a discounter. Two examples are Walmart and McDonald’s, both of which have successfully penetrated their target markets. Small businesses rarely employ this strategy for obvious reasons; they’re not set up for high volume sales and can’t compete with giant discounters.

Value pricing is far more attractive to small businesses because it draws the most potential buyers. It’s also where most of your competition focuses its attention, making it even more important to differentiate your business from the crowd. Prices should reflect your assessment of the sweet spot that’s low enough to attract large numbers of customers, yet high enough to make a reasonable profit based on expected sales volume.

Premium pricing establishes your business as one that seeks upscale customers who believe higher prices equate to exclusivity and superior quality. These customers will pay more for products that make them feel special and distinct from the everyday shopper. This approach relies on premium branding and marketing that emphasizes luxury and high margins at the expense of lower sales volume.

Summary
The science behind pricing is the easy part. It’s the art that will determine how well your business performs. It helps to test different approaches and keep track of the results. If you run a discount sale for two weeks and the increased volume more than offsets the lower margins, consider adjusting your prices accordingly.

Keep in mind the old adage that something is worth what someone else is willing to pay for it. Tweak your prices until you find the price points that optimize your overall business strategy.