Pricing is one of those things that most small business owners figure out by feel, by looking at what competitors charge, or sometimes just by pulling a number out of thin air. Then they leave it alone, for years or maybe add a random cost of living increase every now and then. Sound familiar?
The problem is that pricing isn't just a number, it's a statement about your business, your value, and your costs. Getting it wrong doesn't just hurt your margins, it can quietly weigh down a business that looks healthy on the surface.
There are a few common pricing strategies you should know. None of them is universally right, and most businesses end up using a combination of more than one.
Cost-plus pricing
This is the most straightforward approach. Figure out what it costs you to deliver your product or service, then add a margin on top. If it costs you $50 to make something and you want a 40% margin, you charge $83 ($83 x 60% = $49.80). (See my post on Markup vs Margin if this is confusing.)
The benefit is that this method is simple and it guarantees you're covering your costs (assuming you have factored them correctly). The negative is that it ignores what the market will actually bear. You might be leaving money on the table, or you might be pricing yourself out of the market without realizing it.
One thing to be careful about here - make sure you're actually capturing all of your costs. Materials and direct labor are obvious. Overhead, your own time, software, insurance, and the cost of the equipment you use are less obvious but just as real.
Competitive pricing
This is where you look at what everyone else is charging and price accordingly. Either matching them, going slightly lower to compete on price, or going slightly higher to signal that you're a step above.
The issue with competitive pricing is that you are essentially letting someone else make your pricing decisions for you. If your competitor has lower costs (owns instead of rents or has been in business long enough to have their loans paid off), better volume, or is simply willing to make less money than you, following them is a race you probably don't want to run.
That said, knowing what the market can handle is important context for any pricing decision you make.
Value-based pricing
This one can be more difficult but it can also be the most rewarding. Instead of starting with your costs or your competitors pricing, you start with the question: what is this worth to the customer?
If you save someone ten hours a week, what is that worth to them? If your product prevents a problem that costs a business thousands of dollars, what is that worth? The answer to those questions often justifies a price that cost-plus math would never get you to.
Value-based pricing works best when you have a clear understanding of the problem you're solving and who you're solving it for. If you have something that is treated like a commodity (easy to get and very similar from various vendors) then this pricing will probably not work.
A few things that can trip people up
Not accounting for your own time is probably the most common mistake. If you're a solo operator or a small team, your time is a cost. If you're not pricing it in, you're not paying yourself - remember if you were not doing it you would have to pay someone to do it.
Discounting without a strategy is another one. A discount here and there feels like good customer service. A pattern of discounting tells the market your real price is lower than what you're asking, and makes it very hard to charge full rate later on.
And the markup versus margin confusion trips up more people than you'd think. A 20% markup and a 20% margin are not the same thing. (See my post on Markup vs Margin if this is confusing.)
So where do you start?
Honestly, most small businesses should start with cost-plus to make sure they're not losing money, layer in competitive awareness so they understand the market, and then work toward value-based thinking as they get clearer on the problem they solve and who they solve it for.
And if you haven't looked at your pricing seriously in a year or more, put it on your calendar now so you take the time to review your pricing.
This post is meant to help you think through pricing concepts, not to serve as financial or accounting advice. Your specific situation may have factors that change the math significantly. When in doubt, talk to your accountant.