Pricing strategies to improve your cash flow

As a small business, developing a pricing strategy is crucial to improving your profit margins and sales figures. Set the price too low, and your business might suffer from cash flow problems. But if you set the price too high, you stand to lose customers, particularly in the face of strong competition. The answer is to price your product or service at the right level that will not only allow you to meet your profit goals, but also to keep or increase your market share.

Before you begin

Firstly, it is essential to understand the market you operate in before you make any pricing decisions. Conduct some market research to determine who your competitors are and how much they are charging. It is worth checking out their websites or going into their stores (if they have a physical location) to find out how your product compares to theirs. It will also give you insight into what the key features and benefits of their products are, and if they can be differentiated from yours. Your SME will benefit if you have a clear advantage, such as product add-ons, free installation or improved quality.

You can also rely on industry surveys and reports about your chosen line of business to provide information on consumer demand. For example, the Department of Agriculture, Fisheries and Forestry (DAFF) releases regular reviews and statistics on topics ranging from agriculture and biotechnology to quarantine and exports. Pricewaterhouse Coopers has also recently released its 14th Annual CEO Survey for the retail and consumer sectors. Once you gather enough information, you can then determine if your selling price is cost or value-driven.

Cost-driven pricing

A cost-based or cost-plus pricing method is derived from how much profit you want to make. This involves adding on an amount you need to make a profit onto your production costs. For example, if you want to make a 20% gross profit margin on your $100 product, you will charge $120. You can also use the Western Australian small business website to calculate your break-even point and profit target.

The cost-plus method is effective because it tells you if your prices are reasonable. If your prices are less than your direct costs, you will make a loss. If your prices are higher than your direct costs, the money you make will go towards covering your fixed or overhead costs. The National Australia Bank small business guide recommends getting your calculations double-checked by an accountant. However, the pitfalls of this method are that you cannot determine the level of demand or market expectations for your product.

Value-driven pricing

This method refers to setting prices based on what the consumer is likely to pay, and on the 'value' of the product or service. For example, if you own a café business, it is reasonable to charge $3 to $4 for a regular sized cup. However, if you want to charge more for a cup to raise your profits, you will need to convince the customer why they should pay more. This usually involves a significant amount of marketing or publicity, which most small businesses do not have the resources to undertake.

The reason why larger companies such as Starbucks can charge around $5 to $6 for a cup is because customers perceive the coffee chain as 'branded' and 'luxury'. Unless your business offers a niche or unique product, you will be better off setting your price point at the market standard. Once demand picks up, you may be able to increase your prices.

Other strategies

Discounting your products is also a good way to attract demand, but be wary of setting your prices too low. You will need to cover at least your day-to-day costs and have enough to survive on, as well as account for variations in sales volume.

According to NAB, you should determine how much you need to sell to make up for the discounted prices lest you fall into a price war with your competitors, especially if you're a less established business. Your small family-owned grocery store will not be able to compete with Coles or Woolworths in a price war. Supermarket chains have deeper pockets, and usually, a powerful parent company that can bail them out if their businesses are struggling.

A possible solution is to establish an agreement with your supplier to exclusively distribute their products so you can avoid competition with big companies. This also ensures that your business is the only place customers can get that good or service from.

Another strategy is adding value to your products and selling them as a package deal. According to the NSW Small Business website, this involves throwing in extended warranties, free deliveries or additional product features to lure customers.

Whatever pricing strategy you choose, you should regularly review your price and profit objectives to ensure you are keeping in line with your company's vision and goal. Once you consider the wants and needs of your customers, as well as the cost structure of your business, you'll be on your way to improved cash flow and increased market share.

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