The Fine Art of Price Setting

It's a matter of balance. You went into business to make money and the concept of chalking up profits is fairly simple: Your company has to take in more than it spends.

And your prices play a large role in that. In fact, price tags have a big job -- they must be attractive enough to retain customers, lure new business and at the same time cover costs and generate profits.

It's part art and part science: The fundamental trick is knowing how much you need to make to exceed what you spend. So step back and review what you've been doing and follow these nine basic principles of what prices must do:

1. Cover costs. Even if you love what you do, it's a hobby unless you make money. Figure out how much you need to make to keep the business afloat after paying yourself, your staff and all expenses. Calculate how much you spend making your product and you have a solid base figure to start with.

2. Include "added value." Think about what makes your goods and services worth more than their costs. Ask yourself what's special about what you do or the way you run your business.

For example, you can charge more if you guarantee delivery on a fixed schedule or make a product that's healthier or easier to use than your competitors. Added value also includes your time, talent, investment and risk. Don't give them away. Remember what Frank Perdue, former president of Perdue Farms had to say about value and pricing. "Customers will go out of their way to buy a superior product... and you can charge them a toll for the trip."

3. Reflect the market.  The sticker you put on your product takes into account demand, customer needs, changes in customer tastes, the life span of the item and how it's going to be used.

4. Maintain margins. When making long-term price cuts, you must also lower costs to maintain your profit margins. Remember the simple formula: Prices equal costs plus profit margins.

5. Meet your business goals. Occasionally you need to adjust prices to get new business or improve your cash flow. For example, you might offer discounts during the off season. Perhaps you have lower prices for customers who pay their bills quickly or buy in bulk. Or maybe you have a policy of matching your competitors' prices. These procedures are fine, but have a firm floor figure in mind when you cut prices and stick with it.

6. Be attractive. Gauge what customers are willing to pay. You may be making the world's best mousetrap, but if the price is too high, no one's going to buy it. On the other hand, don't charge less than consumers are willing to pay.

7. Be competitive. It's not enough just to match or undercut the competition. Buy their products and use them. Size up their customer relations. You may have competitive advantages that allow you to charge more. Price isn't always the first thing on a customer's mind.

8. Move inventory.  Beating the competition isn't your sole pricing strategy. Your inventory needs to move and your prices should be set as high as possible while still accomplishing this goal.

9. Review. You may find that you set your prices too high or low or that economic conditions have changed or that you miscalculated demand.

If you follow these principles when mapping out your pricing strategy -- and making alterations -- you're on the path to a consistently healthy bottom line.