Chapter 4

Guide to pricing strategies and the cost of goods sold for small business owners

Your prices can influence the number of sales you make and the profit you earn on each transaction.

Person holding large novelty numbers.

As the old adage goes, everything has a price. But how should you go about setting yours?

Prices are personal and powerful – they can dictate the balance of cash flow, number of sales, and profitability of your business. The good news is that there are plenty of models and pricing strategies to help you get it right.

In this guide, we explain the pricing strategies you can use as a small business owner. Learn how to calculate the Cost of Goods Sold (COGS) and the impact of inventory levels on pricing, and discover your route to fair and feel-good pricing.

The first rule of price setting - find out the Cost of Goods Sold (COGS)

If your price doesn’t exceed the cost of creating your product, you’re never going to make a profit.

So knowing the cost of a sale is key to setting prices (that actually pay off).

Let’s explore further.

What is the Cost of Goods Sold (or services sold)?

Cost of Goods Sold, or COGS, tells you what your business spends to deliver a product or service to your customer. It’s treated differently to general costs like rent or employee wages.

COGS is one of the key factors that come into play when setting your pricing strategy. Low pricing that fails to account for COGS could mean you only break even, or don’t make a profit at all.

When identifying what COGS is in your business, look for expenses that:

  • Occur only when a service or good is provided
  • Go up and down as sales go up and down

Cost of Goods Sold Formula

You can get a good idea of your COGS or your COSS (Cost of Services Sold) by performing this calculation:

Some of the above costs may not apply

Bear in mind that your business might not need to take all of these cost categories into consideration. For example, if you deliver a service remotely, you may not need to factor in travel costs.

What are pricing strategies?

Now that you know your COGS, you know the minimum amount you have to charge to make money. But it helps to have a system to work out what you should add on top. That’s what a pricing strategy is.

In the next four sections, we share four common pricing strategies for you to experiment with. You might find a combination of different pricing methods works best in your business – so don’t feel you have to stick with one.

1. Cost-plus pricing strategy

A cost-plus pricing strategy means you add a standard markup to the production or acquisition cost of everything you sell.

For example, say you purchase plant pots directly from a manufacturer to resell. The manufacturer sells them to you for £3 a piece, and your markup is 30%. You would charge a set price of £3.90 per plant pot.

The price of your product or service may encompass multiple factors. For example, the cost of materials, labour, overheads and any other direct expenses associated with production.

As part of your price setting, you should consider factors such as your desired profit margin, market competition and customer perception. If your direct competitors are selling at a 45% markup, you may be missing out on a higher profit. Equally, you may have a greater customer base for charging lower prices – so it’s important to weigh the pros and cons.

2. Going rate or market-based pricing strategies

This pricing strategy requires some research. With going rate or market-based pricing, you look at the range of prices that your competitors charge and:

  • Go higher if you offer more convenience or a premium experience
  • Match the average if you don’t want to turn off price-sensitive shoppers

Unless you have a steady supply chain and expect lots of sales, it’s best not to go lower.

The ‘going rate’ or ‘market-based’ pricing strategy is popular with businesses that stock similar products as their competitors such as retailers.

3. Price bundling

By bundling a few things together at a slight discount, you can provide customers with a good deal and increase the average spend at your store.

While your profit margin might come down slightly, this pricing model can help you stand out from your competitors and simplify the purchasing decision for customers.

You’ll need to be strategic about price bundling, though. Consider combining products that are complementary or related to each other – for example, bundle your plant pots with watering cans or garden gloves.

And make sure it’s obvious how much the items cost separately, so customers can clearly see that they’re getting a better deal.

4. Launch pricing strategies

New products (or businesses) sometimes feature temporary pricing strategies to try and grow their customer base. These include:

  • Penetration pricing: Where you lower your prices to increase sales volume. This can attract new customers fast, but the trick is to keep them when your prices go up.
  • Price skimming: Where you hike prices on new products or services, believing that enthusiastic early adopters will pay more. Then you lower prices later on.
  • Sweetener deals: Where you set prices high but offer introductory discounts. This allows you to create the feeling of a deal without permanently devaluing your product or service.

More pricing strategy examples

The pricing methods outlined above are commonly used by small businesses. But throughout the year, you might want to incorporate different pricing strategies to keep your customers hooked.

Here are some other pricing strategy examples you can try:

  • Seasonal pricing: As the name suggests, seasonal pricing involves tweaking your prices based on the time of year. Charge less during off-peak times, and more at the height of demand.
  • Loyalty pricing: Reward regular and returning customers with discounts and savings. Special pricing for your top customers can encourage them to keep coming back.
  • Dynamic pricing: Prices are adjusted in real-time, based on market fluctuations and customer demand. This pricing model can also create a sense of urgency for customers who want to lock in a good deal before it’s too late.

Tips for business owners when setting prices

Setting prices for the first time is tricky. It’s likely you’ll need to experiment with a few different strategies and methods before settling on the right ones. Here are some tips:

  1. Establish how much of a profit margin you want. It’s no good setting lower prices than your competitors if you’re barely taking a cut.
  2. Combine pricing methods to keep things fresh for customers. Offer loyalty pricing to keep regulars coming back, and bundle items based on seasonal demand.
  3. Test different pricing strategies to see what sticks. Your customers might flock to cost-plus pricing, but turn away from bundle deals. Experiment to see what goes down well.
  4. Plan for the impact of sales and discounts. Treating your customers to lower costs is great, but make sure you budget and forecast so you can see how long those prices are sustainable.
  5. Measure, analyse and adjust. The pricing model that works best for your business at first might not work forever. Regularly assess your price setting strategy to make sure you’re getting the best out of it.

Pricing methods and COGS are key to profitability

You have two levers for making money in business – your margin and your sales volume. They’re both affected by price. So give lots of thought to what you charge.

Accountants and bookkeepers can support a lot with the numbers too and help you to create strategies for effective cash flow management. They understand industry norms and can help tell if your margins are too thin. You can find a Xero-ready accountant and bookkeeper in our advisor directory.

Xero as your pricing strategy partner

You’ve explored the types of pricing strategies – now it’s time to start selling. With Xero’s accounting software for small businesses, you have much of the data you need to create fair and competitive pricing.

Access customiseable reports, cost management features, and real-time data that shows you exactly what works for your business. Get granular data about COGS, and discover how you can better serve your customers (and your bottom line).

Check out our small business guides for tailored support on sustaining a healthy business or our expert guides and articles on cash flow management.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

How to start a business

Thousands of new businesses open every day. If all those people can do it, why not you? Here’s what to do, and when.

  1. How to do market research

    Your business idea is clearly inspired. But it helps to check you’re not the only one who thinks so.

  2. How to write a business plan

    Writing a business plan will help nail down your idea and give you a blueprint for executing it.

  3. Budgeting and forecasting

    It’s time to run some numbers on your business idea. Budgeting and forecasting help with that.

  4. Pricing strategies and cost of goods sold

    Your prices can influence the number of sales you make and the profit you earn on each transaction.

  5. Types of business structure

    Your business structure can affect how much tax you pay, and how you're treated by the law.

  6. Small business accounting

    If you’re starting a business, then you’ll need to get familiar with some accounting basics.

  7. Registering a business and other admin tasks

    After all the excitement of deciding to start a business, you’ll have some paperwork to do.

  8. How to create a business website

    Treat your website like an online version of a storefront. It’s the first impression for many customers and prospects.

  9. Tools and guides for your business

    Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.

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