How much should I charge for my product or service?

Setting a price for your products and services can be a delicate balancing act - charge too much and you risk driving your customers to a competitor; charge too little and you end up diminishing your profits...

There are many factors which will have an influence on pricing and the better your understanding of these, the more likely you are to set the right prices. So before you even start working out your pricing policy, you need to gather together information on the following:

Your customers

When defining your pricing policy, you must have a good understanding of your customers. What price would they be prepared to pay for your product or service? What do they really value and what influences their purchasing decisions?

Bear in mind that customers buy products for a whole variety of reasons - often seemingly paradoxical ones - and you must be able to identify what motivates them to choose you over a rival. It's also important to remember that there is often more than one person involved in the decision to purchase your product and so you must know specifically who you are targeting.

Your market and your rivals

Find out who your competitors are, how much they charge, what products or services they are offering and what discounts, special offerings or loyalty schemes they have in place. Try to get an understanding of the state of your target market and what it thinks of your competitors' offerings, identifying their weaknesses and strengths.

When setting your prices, you should consider how you can position your offering to exploit these shortcomings or whether you are in a position to compete head-to-head against your rivals' strengths.

Your costs

Costs of a business are normally divided into either fixed, semi-variable or variable.

Fixed costs are ones that are incurred regardless of the level of a company's activity - salaries, rent and utilities are examples.

Variable costs on the other hand are ones which rise and fall according to the level of production. These include overheads such as packaging, freight and raw materials and are sometimes also called Cost of Goods Sold or COGS.

Semi-variable costs are ones which have an element of both fixed and variable, such as mobile phones. It is most important that you know exactly what your costs are before you attempt to set your prices.

Your offering

List all the benefits of your offering - its unique selling points and strengths - and work out how much your customers will value them.

Given your market research, how much are these benefits worth in cash terms?

The benefits will vary greatly from product to product and from market to market but you do need to establish that what you are offering is in line with what your customers require, value and expect. For example, customers will be willing to pay your company more for a new computer if your back-up service is reliable and of a high quality.

Your business objectives and strategy

This will also influence your pricing. You should take into consideration in which direction you want the company to develop and how quickly. There may be pressure from investors to expand quickly or emerging markets that you want to secure a place in. It may be part of your strategy to simply sell cheaper than your competitors or to charge a higher price for a high quality product in order to position your product as of even higher quality.

How much money you need to live on

As well as generating enough cash to cover your overheads, repay loans and keep your investors happy, you also to have cover your own living costs. You can't live on thin air and the chances are you already have a number of financial commitments - food, mortgages, pension funds, school fees or whatever - that you have to be able to meet.

The price you charge multiplied by the number or times you are likely to sell your product or service each week or month has to be enough for you to be able to draw the salary you need and want while still allowing the business to survive.

HM Revenue and Customs

This tax-collecting organisation estimates how much a business of your sort in your part of the country should be making. When you file your tax returns or VAT returns they will query figures which don't conform to the norm. This doesn't mean you have to do exactly the same as everyone else, but if it is vastly different, you and your accountant may have to be able to explain why - and prove it.

Once you've considered all of this, you then need to decide what pricing technique you want to adopt.

Mark-up and margin pricing

This is where your profit is either determined as a percentage of the cost price or of the sale price. Where the profit percentage is based on the cost price, it is referred to as mark-up. Where it is based on the sale price it is known as margin.

Pricing by competition

This type of pricing is common where the products for sale are available from a large number of suppliers, the margins are narrow and the customers are especially price-sensitive. Also called going-rate pricing, it effectively means that you match the prices that are being offered by your competitors.

Break-even pricing

Breakeven pricing is where you calculate the break-even point of your business - the point at which your sales income and your fixed and variable costs are equal - and set your prices by adding your profit margin onto your unit price.

Perception pricing

This type of pricing technique may require a significant amount of market research. It is often suitable where a brand new type of product is being introduced into the marketplace and the price is determined by what your target market perceives to be its value, in other words, how much they would pay for it.

Rule of thumb pricing

The rule of thumb technique is simple and lends itself better to certain types of businesses such as construction or repair services. An example of a rule of thumb formula would be where a building contractor would charge twice the cost of the raw materials plus labour or twice the cost of the labour plus the raw material costs, whichever is the greater.