What Every Entrepreneur Should Know About Pricing
No matter what you’re selling, the “right” price to ask is never clearly defined. Chip Averwater, a third-generation retailer and chairman of Amro Music Stores in Memphis, TN, has seen it all and has developed a list of tried-and-true pricing advice for other business owners. Here are Averwater’s top pricing tips.
By Daniel Kehrer
For many small businesses, survival depends increasingly on finding the ever-elusive “right price” for whatever goods or services are being sold. But there’s no magic formula. No matter what you’re selling, the “right” price to ask is never clearly defined.
For one thing, costs differ from business to business. Online businesses, for example, don’t have the overhead of staffing retail stores and often aren’t subject to the same sales taxes. So an online store can sell at a lower price and still make a profit.
Chip Averwater, a third-generation retailer and chairman of Amro Music Stores in Memphis, TN, has seen it all and has developed a list of tried-and-true pricing advice for other business owners. Here are Averwater’s top pricing tips:
- The right price isn’t a multiple of wholesale. It’s tempting to price by simply using a fixed-percentage markup from wholesale. But that strategy assumes all expenses of a sale are determined by the wholesale cost. To price correctly, argues Averwater, you must do it individually and by feel, with consideration given to the total expenses of the sale, customer price sensitivity, competitive options, and the sale’s potential contribution to other business.
- Know the difference between wholesale cost and cost of the sale. Wholesale is the cost of the merchandise, not the cost of the sale. Think about it: The price paid to the manufacturer is only the first of many expenses in a transaction. Sales can’t be made without including expenses for rent, salaries, advertising, utilities, freight, maintenance, taxes and others. Just because a sale has a gross margin doesn’t mean it’s profitable. Unless the price covers all of the sale’s expenses, you are taking money out of your own pocket to make it.
- All sales should bear operating expenses. Some business owners subscribe to the theory that since expenses are fixed, so they should accept every sale that has a positive gross margin. But here’s the problem: When are expenses ever really fixed? Sales don’t happen in a vacuum. Boosting sales requires increases in personnel, space, inventory, handling, and virtually every other business expense. In fact, every sale incurs operating expenses so its price should be sufficient to cover them plus a profit.
- Practice your pricing math daily. Turns out your math teachers were right. You do need this skill to survive in the real world. You need a clear idea of the cost of every sale, service, and activity your business engages in. That information helps you decide what to stock, what to promote, where to channel your investments and efforts, and of course, set prices. Averwater’s advice is to regularly sit down with a spreadsheet and divide the list of expenses across your product sales and services. Only then will your costs become clear.
- Don’t try to offer the lowest price. You’ve probably seen it before: Weaker competitors offer lower prices to attract more customers. At first glance, this might not seem like a bad strategy. But those companies are crossing their fingers and hoping that when the dust settles, there will be a little profit left over.
“It’s futile to try to price below desperate competitors because they’ll always drop their prices below yours,” says Averwater. “Differentiation is almost always a better strategy. Offer superior products and services that customers are willing to pay more for.”
- Reputations are made on price-sensitive items, margins on the rest. Price-sensitive items are the ones bought frequently and advertised often. In a grocery store, they’d include bread, milk, and soft drinks. In a musical instrument store, they’d be strings, reeds and picks. Because customers buy them often, price differences between stores are more apparent.
“Pricing these items low creates a value image for the store,” says Averwater. “Higher margins on other merchandise allow the store to make a profit.”
- It won’t sell if it’s not on sale. Americans love the thrill of a bargain. In fact, customers have become so accustomed to discounts that many won’t make a significant purchase unless the product is on sale. Many furniture and clothing stores schedule only brief intervals between sales, which they use to catch up, restock, organize and collect prospects for the next sale. Many department stores end one sale only as the next begins.
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