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Pricing Model: What Will Make or Break Your New Business

setting the right pricing model and price points are important for a new business

So you came up with an idea for a new business. You’ve thought it through and still think it’s a solid idea. You’ve even done some preliminary research and know roughly how much money you’ll need to get to the point of making that first sale. Next, you’ll need to have a plan on how to sell your goods or services, and for how much. In other words, you’ll need a pricing model and some initial price points.

You might change the model and the prices a few times even before your grand opening, but that’s OK. Your pricing model can make or break your business, so don’t be afraid to change or tweak your plan as you get more customer data. As long as you continue to think about your pricing model, you’re on the right track.

What Is Price Point and How Do You Set It?

The price point is the dollar amount at which you plan to sell your goods or services. With the right pricing model and at the right price point, you’ll be able to gain market share or create market share, regardless of how much your industry is worth.

The price point is not a number that you pull out of a hat. Admittedly, though, setting the price point is more of an art than a science—especially for small businesses that don’t have the budget for market studies with focus groups. Fortunately, there are a few factors to think through to help you set the price point.

What is the Total Cost of Your Goods or Services?

To set a good price point, you’ll need to know how much it costs you to buy the goods or the materials to make the goods. Then, you can add a profit margin on top to get to the price point.

Include estimated labor costs, material costs, equipment costs, supply costs, lease, and similar. Basically, include everything you expect to spend as a business.

What’s Your Competitor’s Pricing?

Even if your marketing strategy is to charge less than your competitors, there’s no need to charge too much less. Set your price point just lower enough to entice consumers to buy from you.

You might be able to find a rough range of how much your competitors charge just by doing internet searches. If you think you’re the first in a brand new industry, find the closest comparable industry and look at the price points of the companies whose customers you expect to “steal.”

Do You Have a Target Profit Margin?

First, a word of caution: it doesn’t always make sense to price this way. If your cost is low and you can easily undercut your competitors, it doesn’t make sense to set your price point exactly at your target profit margin. It would be better if you simply price slightly below your competitors and have a profit margin above your target.

If your expected profit is below your target margin, then, at some time in the future, you might want to think about whether you’re working too hard for too little profit. But, for now, just be aware that this is one way to set price points. You don’t have to follow this method if it doesn’t make sense to do so.

Make Your Best Educated Guess for Now

At this early stage of your business planning, you’ll have to make a lot of guesses to build a pricing model and set the individual pricing points. But that’s fine. Take your best guess. This way, you’ll have at least a starting point. As your planning gets more detailed, you can refine your price point.

Understand Your Marketing Strategy and How Your Pricing Model Fits Within That Strategy

Price point and marketing strategy are closely related, especially if you’re in the service industry and you run on a membership/subscription pricing model. With the correct marketing strategy, you can drive your customers to the price point where you make the most profit. Just make it easy for customers to see that the price point you want them to pick gives them the best deal.

Below are three classic marketing techniques to think about: loss leader, cross-selling, and upselling.

Use a Loss Leader to Gain Entry

A loss leader is a product or service sold at a loss to entice customers to buy other items at full price.

If your product has a reusable component and a single-use component, consider giving away or selling the reusable component at a loss. Your goal is to entice customers to come back to buy the single-use component set at a price point where you make money. This way, you make money in the long run on repeat purchases.

Upsell Customers by Showing They Can Get Better Value

Upselling is usually used in services with different service tiers. You try to sell the customer a more expensive tier by giving them more bang for their buck.

With a lot of tiered services, the lowest tier is usually a free/pay-as-you-go tier. The higher tiers might require a monthly subscription payment.

Wireless carriers are notorious for using this tiered marketing technique. Notice how they push customers to the more expensive tiers by offering unlimited data when they know full well that most customers won’t use that much.

Pay attention to how you break down the tiers so your customers will feel like they get good value for each tier. You could also drive customers to the tier where you have the best profit margin by giving them extra services at that tier.

Be Helpful and Suggest Related Goods and Services by Cross-Selling

Lastly, if you have several types of products or services, once a customer buys one, you could suggest they buy a closely related item. For instance, if they buy a smartphone, you could suggest they buy a protective case as well. This is classic cross-selling.

You can come up with marketing ideas such as these by researching what your expected competitors are doing. Also, don’t be afraid to try out-of-the-box ideas by looking in unexpected places or industries. You might have to try a few strategies and pricing models until you find one that works best for your business. So, stay flexible and experiment.

The IP Licensing Business Model Almost Never Works for Small Businesses

Let’s briefly examine what is sometimes called the licensing model of running a business. Typically, this involves coming up with an invention. Instead of making or selling the invention yourself, you go to larger companies and try to convince them to make or sell the product. In return, they pay you a royalty.

On paper, this sounds perfect for the inventor—you get a cut of the profits but don’t have to deal with the headaches of running a business. In real life, things almost never work out this way.

Large companies tend to be wary of such invention offers. In fact, if your idea is viable, these larger companies are probably already developing a similar product. To avoid being accused of stealing your invention, the standard legal advice given to these larger companies is to not talk to the inventor at all. Even if the larger company does agree to a meeting, they tend to politely refuse the offer anyway.

If you have an invention, the better approach is to start making and selling the product yourself. Once you’re successful, potential buyers will come to you. Then, it would be much easier to sell your entire company for a larger profit.

So How Firm Does Your Pricing Model and Price Points Have to Be?

At this very early stage of your business planning, it’s good to be thinking about your price point and your pricing model. However, you should also know that, almost certainly, you will make changes to one or both before you start selling your products or services. Not only that, even after you go to market, you’ll still be tweaking here and there to adapt to market conditions.

If you wish to survive or thrive as a business owner, then accept that your plans will always evolve. So, be bold right now. And then carefully adjust as you continue to plan your business.

Interested in starting and running a small business? Here’s the beginning of our step-by-step guide: What to do right after getting that great business idea.

Questions? Comments?