The Secrets to Price-Setting

Price is the most important factor in determining profit. Yet countless businesses fail to get their pricing strategy right

The price you charge for your products or services is a major way you communicate your firm's value in the marketplace. Yet many small business owners set prices arbitrarily or sheepishly follow the crowd. Jerry Bernstein, a pricing expert and founder of St. Louis-based Price Improvement Team, says getting prices right is not only important, it can make or break your firm's profitability. He spoke recently with Smart Answers columnist Karen E. Klein about mistakes entrepreneurs make in their pricing strategies.

What's the most important point you make with clients about pricing?

Believe that pricing is important and that it can be managed. For example, a 1% gain in price will give you the largest percentage increase possible in your operating profit. Reducing variable or fixed costs by 1% doesn't do as much, but an increase in price goes right to the bottom line. Yet you'd be surprised by how few even large businesses, with huge corporate staffs, pay attention to their pricing—let alone small and medium-size firms.

What constitutes "paying attention" to pricing?

Doing more than setting prices in an offhand manner. Taking time to understand who your competitors are, what they're charging, and what you should be charging. Of course, you don't want to solely use price as a means of getting business, but you do want to be aware of how you stack up against the competition. And you want to find ways to structure your prices that will enhance your profit.

How do you recommend doing that?

Segment your business and look at the various chunks. For instance, some products or services will be more price-sensitive than others. Let's say you run a postal center. You don't want to institute a big increase in your price for stamps, because your customers will immediately compare those prices with what they'd get going to the U.S. Post Office.

So, you'd structure your price on stamps to get customers in the door. But what will you charge for the add-ons—things like boxes, tape, labels, markers, and copies? Your customers are there, they want to get their packages mailed, you're providing a convenience for them. They probably won't feel gouged if you do a small price increase on those items, but that's where you'll make your profit.

Here's another way to think about pricing. Let's say your company does expert data-room management for other companies. Look at the various revenue streams you might have and how you should price them. If you do 24-hour emergency calls, that might differentiate you from your competitors. That means you can charge more for that service.

Then, you can establish a relationship with those emergency clients and maybe sell them a one-year maintenance contract, and products to support that, so they'll have fewer emergencies in the future. You'd charge a different price for that. Finally, you could offer them things like training seminars. That would again present a different perception of value to your clients that will drive what you can charge.

A lot of small companies may be reluctant or even afraid to raise prices. Is this justified?

I encourage them to just think about increasing their prices by as little as 2% or 3%. Sometimes they find that their customers don't even notice. Some clients of mine have increased prices by as much as 15% and their clients don't notice!

What's another problem pricing area?

Discounting. A lot of companies sell at list price sometimes but give arbitrary 5% or 10% discounts to regular customers or for a certain volume order. They need to understand and control what they're doing because a lot of times this area is under the radar and they may be discounting unnecessarily or without an awareness of what it's doing to profitability. Rather than 5%, why not discount 4% or 3% instead? That 1% or 2% will do a lot to your profitability over the years.

Another area is customer mix. Certain customers are generally better for your business than others. You need to identify them and figure out what you're doing right with them, and what you're doing wrong with the others.