Do you know how to price your products?
You know how to make your products, and you know what it costs to produce them. But do you know what to charge for what you make?
Like most businesses, manufacturers must make enough profit on their product sales to generate an adequate return on investment (ROI). The difference for manufacturers is that setting prices based on margin information may not adequately reflect production time. A high-margin product that moves through the plant slowly may actually be less profitable than a low-margin product you can produce in half the time.
Consider your approach
There are several ways to approach pricing. One is cost-plus, in which you set your price at your production cost plus a certain profit margin. Another option is target return pricing, where you set your price to achieve a designated ROI. Still another possibility is value-based pricing, or setting your prices according to the value your products create for your customers.
Finally, there is psychological pricing, or setting prices according to how your customers perceive your products. If, for example, you want to be viewed as producing high-quality products, consider pricing them higher than the competition.
Bear in mind that there’s a limit to how much customers will pay for a product. If you exceed their view of what’s fair, they won’t do business with you.
3 key factors
So how do you set prices that will generate the profitability you need on all your products, regardless of per-unit margin? The answer depends on the same three factors that influence all pricing: 1) competition, 2) customer sensitivities and 3) positioning. The best pricing strategy is probably a combination of all three.
When it comes to your competition, use their pricing as a guideline, but don’t take a loss just to undercut them. You could end up in a price war that no one wins and that devalues your products in the eyes of your customers.
Speaking of your customers, you need to get to know them, too. What other products are they buying, and why? Do they value your quick turnaround enough to pay more for your products? If not, what can you offer that they will value more?
Then look at how you’re positioned in the market. If you need to ask your customers to pay more for your product than for something your competitor makes, you need to be viewed as a higher-end provider.
Oddly, customers given the choice of buying a DVD player for $10, $100 or $1,000 will most often choose either the $10 or $1,000 product, according to a study by Boston Consulting Group. The middle market is most likely to suffer.
Thus, you may fare better if you choose to skew your pricing toward either budget-minded buyers or those who’ll pay a premium to get the best available — unless you take a page from Toyota’s book and make value-based products under one name (Toyota) and budget and luxury goods under others (Scion and Lexus, respectively).
Make price adjustments
Either way, you may need to adjust your pricing to determine what gives you the best return on your investment. You can’t keep fiddling with the price and expect to keep customers coming back for more, but you can have a “sale.” Offer discounts of 10%, 20%, 30%, etc., and measure which pricing point gets you the biggest ROI.
It’s more difficult to experiment with price increases, but one way is to reduce your costs of goods sold while leaving your prices unchanged. For example, instead of selling five pounds of flour for $2, make the bags smaller; sell four pounds for $2. Again, experimentation and measurements will tell you what price gives you the biggest ROI.
The price is right
It isn’t easy to set prices, and changing market demands make it unlikely that you’ll ever get it exactly right. But if you keep trying, you’ll arrive at a solid price point — that elusive place that you and your customers agree is right.
For more information about our services to inventory based businesses,
Contact: Mark Walker, Partner, Director of Inventory Based Businesses Practice at 817.882.7724.
The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.