The four basic methods of pricing

There are four basic methods of pricing your product/service, and the best method depends on your type of business, your product/service, what influences your customers to buy and the nature of your competition. Regardless of what method you use, you need to know the market, your customer, the competition, and your costs.

1. Cost-plus pricing

This takes the cost of producing your product/service and adds the mark-up amount that you need to make a profit. This is usually a percentage of the cost. It is important to remember that ‘cost-plus pricing’ ignores value. It is also very easy to overlook hidden costs, so your true profit per sale is often lower than you realise. It is also difficult to keep changing your prices based on fluctuating costs as customers don’t like prices that fluctuate wildly.

2. Value-based pricing

Value pricing is customer-focused pricing, meaning a business bases their pricing on how much the customer believes a product is worth. You can do a lot to increase the perceived value of your product/service because it’s about the customers’ total experience (which we discuss in the next step).

3. Competition-based pricing

This means you set the price of a product based on what the competition is charging. This pricing method is normally used by businesses selling similar products, since services can vary from business to business, while the features of a product remain similar. If there is high competition, you can either keep prices low to compete effectively or increase the value of your offering. If competition is low, the prices can be kept higher.

4. Charge per hour pricing

This pricing is often used by service-based businesses and independent contractors. When using this method, it's important to factor in all your business costs and a wage for yourself.

Here are three influences to consider when pricing your product/service:

1. Location

Location can work both ways: A small business in a busy part of a city can charge more than a similar business in a small rural town simply because city people are more likely to be willing and able to pay a higher price. On the other hand, if you are the only business in a small rural town offering an essential product/service you may be able to charge a higher price.

2. Reputation

Never underestimate the power of an unbeatable reputation. For example, if you offer a service and are always willing to take on last minute jobs, and not only deliver on time but also deliver excellence, you will be able to charge higher prices.

3. The value of your product/service

It’s important to know the difference between cost and value, as it can allow you to charge higher prices:
 

• The cost of your product/service = the amount you spend to bring it to the customer
   
• The value of your product/service = what your customer believes the product/service is worth to them

 

Here’s a simple example: Let’s say that the cost for a plumber to fix a burst pipe at a customer's home in the middle of the night is R50 for travel, R100 for the cost of the new pipe and R300 for an hour's labour. However, when the plumber is there within minutes and immediately contains the flow of water, the value of the service to the customer – who has water leaking all over the walls, furniture, and carpets – is far greater than the R450 cost, so the plumber may decide to charge a total of R600, which is in line with the value of the service to the customer.