The price is right. Isn’t it?

I recently enjoyed a late season holiday on the picturesque island of Madeira. Besides its immense botanical diversity and distinctive fortified wine, Madeira is known for its ‘levadas’ – irrigation channels traversing the island that also conveniently serve as walking paths, some 1,350 miles of them. Whilst their very slight gradient means that they aren’t physically demanding, their narrow width and high elevation – often with sheer drops into the ravines below – do present a mental challenge for the more risk-averse amongst us.  

Set out at intervals along the levadas were small stalls offering refreshments like water, fruit, chocolate, and even beer! The stalls were left unmanned – an honesty box present –and, at just 20 cents for a banana, the prices seemed very reasonable.

Whether it was the perpetual accountant in me, or just an attempt to divert my mind from the dizzying height of the levada, I began to wonder about how much money the local villagers would get from their stalls to justify the effort of setting them up each day. This welcome distraction went on to remind me of the times I have met with business managers who are struggling to decide on the right price for their particular product or service.

It can’t be all that difficult, surely? You start with how much it costs you, add a bit to cover your overheads, add a bit more to make a nice profit, and there you have your selling price. The theory is easy, but there’s a bit more to it in practice…

Trying to establish your costs can itself present a challenge. Fair enough, if you are in the business of retail and simply buying in a product to sell on, then this process is more straightforward. But be sure to include any associated costs like delivery charges. This exercise becomes more complicated if you are manufacturing a product or providing a service, where you need to be aware of the full extent of input costs such as materials and staff time.

Even in a retail scenario, things can go wrong: in one case, I encountered a grocery store that was selling loaves of bread at less than it cost them to buy from their supplier. Was this an ingenious strategic decision? Sadly not, their database of cost prices was simply out of date!

Once you are confident that you have a full understanding of your cost of sales, there are a number of other questions that you need to consider before setting your sales price:

What is your objective? To make as much profit as possible, right? In the long run, yes. But if you are looking to establish your product or business quickly, you might choose to set a lower price initially (it can, however, be difficult to increase your prices once customers are used to them – make clever use of discounts and promotions instead). Or you may choose a lower price in order to sell in very high quantities (again, offer bulk discounts).

How do you want to be perceived? Are you offering an economy option or does your brand represent the luxury choice? If the latter, then you have an opportunity to charge a premium price – in fact, there is a risk to not doing so, since customers may dismiss you as being too mainstream for their “exacting tastes”. Even in this difficult economic context, people will pay for good quality – the remarkable rise in sales of Mulberry handbags is testament to this.  

Could one sale lead to another? Some companies will target new customers who aren’t initially profitable, but are expected to become so in future. This is why credit card providers will offer 0% interest on balance transfers. Similarly, a business may be able to sell a product at little or no profit because the customer then becomes bound to buy associated products or services from them. Mobile phone companies, for example, will give away handsets for free, knowing that they will earn their profits from monthly call and data charges.    

What are your competitors doing? The UK’s top 3 supermarkets are all currently running high-profile marketing campaigns which guarantee the best prices for their customers. Whilst this intense monitoring of each other’s prices is an extreme example, it is nevertheless important to keep an eye on the competition. But you don’t necessarily have to set your price lower than that of your competitors – you can choose to differentiate in other ways. Just make sure that this distinction is communicated to your customers. 

It soon becomes clear that pricing decisions aren’t an exact science. But having certainty about your costs at least enables you to test your prices on the market, knowing what the financial implications will be. The important thing is to treat pricing as a dynamic process – be sure to monitor the response to your prices (by customers and competitors alike) – and to react accordingly.