The Secrets to Price-Setting

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Then you have to figure out whether you want the business from certain customers, especially if you're not making money, or even losing money on their business. At the very least, you need to consider increasing the prices that those customers pay.

How do most small companies set their prices in the first place?

They tend to price in a "cost-up" fashion, which means that they look at their cost of materials, add a markup, and arrive at a sales price. Unfortunately, your direct costs are often very hard to determine, and many companies arrive at the wrong figure on them. The other problem is that this pricing strategy has no relevance to the value that you're putting into the marketplace.

What pricing method do you recommend?

I do a lot of research and then I charge what I perceive my customers see as my value to them. You have to have a good feeling for how your customers perceive, use, and apply your product or service, and then you have to communicate that value in your sales process, your marketing promotions, and your conversations with key customers. Certainly you want your prices to have some relationship to the marketplace, but you also want to optimize profitability and use price to do that.

If your customers don't compare notes, by the way, there's no reason you can't charge them different rates. If a customer calls me, for instance, I can drive a higher perception of value—and thus charge more—than if I'm beating the bushes for clients.

What do entrepreneurs not understand about pricing?

It's flexible. Time and urgency affect pricing a lot. The price you offer is one of the strongest ways you're communicating the value of your product or service.

Another key message is that price is the strongest lever a company has in terms of losing or gaining profitability. Entrepreneurs need to analyze who they are pricing their goods for, whether they're leaving money on the table by undercutting the price, or if they're pricing too high to attract a wide customer base.

Sometimes, it's as easy as having your accountant crunch some numbers to show you how much you earned in various years, at what prices, and what expense levels the company faced. If your prices are staying the same, but your expenses are going up and your earnings are going down, you need to increase prices.

For service businesses, I highly recommend that they charge a per-package rate. Get away from charging based on an hourly rate or a materials basis where a customer sees your prices at the line-item level.

If I charge a fee per consulting project, for instance, clients don't know how long it might take me to do certain things, and they can't break it down and look at what I earn per hour and compare it to what they earn. If I did that, they might say, "Hey, you're making $300 an hour. I don't earn that much!" The thing is they're not buying my time, they're buying my 20 years of experience.