A Citibank® Resource for Your Business
Pricing for profits
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Pricing strategy is a cornerstone in the foundation of any business.
But a higher price is not, by itself, a path to higher profits. In fact,
the relationship between price and profit in your business is a
complex interaction of many factors, including your cost of doing
business, your level of customer demand, and your competition.
And it is unique for every business. Here’s a basic overview of the
principal factors you should consider when seeking to establish
optimal pricing for your business.
Base your pricing on a clear appraisal of your costs
• The cost of producing the product or service is a core pricing consideration
A business activity must generate enough revenue to cover its costs in order to be
sustainable. In evaluating cost, you should account not only for the direct costs of
acquiring inventory and raw materials, but also the costs of production (including
labor costs), sales, distribution, and management. You should also account for the
cost of capital, which is the money you might lay out in advance of the sale for the
salaries, supplies, and facilities needed to produce goods and services.
• Distinguish variable costs from fixed costs
In the context of pricing strategy, a variable cost would be any cost that depends on
the unit volume. A fixed cost, on the other hand, would remain generally constant
regardless of the specific volume of business. Every sale should ideally cover all of its
variable costs and make a reasonable contribution to covering its fixed costs as well.
• The actual cost per unit of what you produce is likely to depend at least in part
on the volume of the units you create
Base your pricing on a clear
appraisal of your costs
Consider market
influences on price
Conclusion:
strike the right balance
Keeping expensive machinery steadily active and getting volume discounts on supplies
and raw materials can help lower the unit cost of whatever you create or distribute.
But while relatively high production volume may offer economies of scale, producing
more than you can efficiently sell could actually drive up your costs. You may incur
extra costs to warehouse unused raw materials and unsold products. You may even
have to make provisions for losses from spoilage, deterioration, or obsolescence.
Consider market influences on price
• Lower prices can spur demand
As the price of something goes down, demand for that thing normally goes up, and
vice versa. Demand for staple items such as motor fuel and essential foodstuffs is
usually considered inelastic because it generally requires a relatively large change
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A Citibank® Guide for Growing Businesses: Pricing for profits
in price to produce a small change in demand. Discretionary items, on the other hand, tend to have a higher
degree of price sensitivity — small price changes one way or the other can have a disproportionate impact on
buying behavior. The price sensitivity and demand elasticity for your product in your environment will both play
significant roles in the viability of your pricing strategy.
• Your market area defines who your potential customers are and what the competition might be
One aspect of a “market” is the physical area you draw your customers from. For a brick-and-mortar store, this
could be a fixed radius around the store’s location. For a service delivered to a customer’s home or office, this could
be the radius around your base of operations. Keep in mind that your prospective customers may have business
alternatives near activity centers other than yours, or even online alternatives that you should be aware of.
• Your competition helps determine your price boundaries
The highest price you can potentially charge will be affected by the prices charged by the competition in your market
area. This includes vendors who can provide the same product or service that you can, as well as sources that
offer products or services that could be substituted for yours. (For example, a movie theater’s direct competitors
are other nearby film exhibitors. But theater operators also have indirect competitors who offer alternative
entertainment forms such as DVDs, television channels, Internet media distributors, and even video games.)
Conclusion: strike the right balance
The lower limit of your pricing range is set by your own cost structure. The upper limit is set by your competitive
environment. You may find competitive pricing information through comparison shopping, in trade and professional
journals, or by consulting trusted associates. You may also find helpful benchmark pricing resources at university
libraries, government-run small business assistance offices, and local trade associations. One good place to start is
the U.S. Small Business Administration website, http://www.sba.gov.
Fine-tuning your pricing strategies
• Discount Pricing means lowering your price at select times or circumstances (e.g., an end-of-season sale).
• Variable Pricing means charging different prices to different customers or in different circumstances
(e.g., discounts offered to retirees or surcharges imposed for services provided outside of normal
business hours).
• Negotiated Pricing is determined only after a discussion between buyer and seller (e.g., sale of a home).
• Value-Added Pricing can occur when you customize a service or product package around a standardized
commodity offering (e.g., a clothing store that includes alterations in the price of a suit or dress).
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