Pricing has a major impact on the profitability of your business. In fact, it's probably the most important set of decisions you make. Even so, a lot of businesses continue to sell themselves short. They may have good sales but they perform far from their profit potential. With the right pricing, they could be achieving both healthy sales and strong profitability.

When you set your prices, you're playing for high stakes. Trying to take the costs out of your business may help profitability, but higher prices can make an even bigger difference. Constantly improving prices and margins should be the aim of every business.

Price fright

Many business owners have price fright - they're scared of their own prices and don't believe they can put them up. This is unfortunate, because there are many businesses that badly undersell themselves and fail to realise that even if the worst happened and they lost some customers, the better margins could still give them greater profits. In fact, it's not even certain that higher prices will lose them any customers at all.

There are many factors that contribute to customers' buying decisions:

• Product availability
• Convenience
• Salesmanship
• Brand
• Quality

Pricing isn't the only factor customers consider and is often not the most important thing they have in mind. And yet, few business people scrutinise their product categories to see where they might charge more. They might know that their prices are barely adequate or too cheap, but they're nervous about putting them up.

The maths of pricing

One way to alleviate that fear is to look at some basic arithmetic to see how much increased pricing helps profits. To keep our example simple, the following calculations do not take business running costs into account.

Imagine that someone buys a product at $10, puts a 50 per cent mark-up on it and sells it for $15. There is a profit of $5. However, if the price can be increased an average of 10 per cent, that profit rises to $6.50. Profit has therefore increased by 30 per cent.

Put another way, that same business might sell 100,000 of these products and so have a turnover of $l.5 million. If prices are increased an average of 10%, an extra $150,000 goes straight to the bottom line.

The impact of a price increase on the bottom line:

Simple arithmetic shows a small increase in price leads to a much greater increase in profits. However, just as important is that you can afford to lose a proportion of your customers and still be better off. In this example, the business could put up its prices by 10 per cent and have 20 per cent of its customers go elsewhere and still be better off.

Of course, done properly, you won't lose any customers. In a competitive market you cannot just increase your prices by a standard amount. Good customer service strategies will allow you to charge more without losing a single customer.

Treating all of your products and services the same and expecting to get the same margins on each is not a good strategy. All of your products and services are not the same: they have different customer demand and different market acceptability and need to be priced individually. Neither should you apply a standard mark-up or profit margin to your products and services.

Instead, do the following:

Charge what the market will bear

This means looking at your prices from your customers' point of view. It means ignoring the cost of your product, your competitors' prices and the size of your margins - you don''t need a calculator to set your prices. The only important thing is what your market will pay for your product or service.

Experiment

You can't know what the market will bear if you don't test it. Pricing is not something that you do when you first offer a new product - it's ongoing, something to be thought about and done every day. You should put your prices up until you hit genuine customer resistance. This resistance is evident when people stop buying. Only then should you lower your prices a touch.

Be flexible

Your product or service will have different demand and will bear different prices at different times. This may be seasonal or it could be short term. There are reports from the USA of soft drink vending machines that are temperature sensitive, automatically adjusting prices up in warm weather and down in cooler weather.

Look at products individually

Apply different prices and margins according to the demand for each. That means looking at everything item by item, colour by colour, size by size. If you sell shirts and find that white ones sell best, you can probably increase the price of these, regardless of the fact that they cost the same as the others to source. Don't be nervous if some of your prices and margins increase significantly - if the market will bear it, charge it.

Add value

Adding value must be done from the customer's point of view - it must solve a problem for them. From the customer's point of view, value is the benefit of the product less its cost. Note that the most value is not all tied up in price. If you sell to retail outlets, you might be able to reduce your customers' costs with better availability, better packaging, a product that stacks better on shelves. This means working with your customers, finding out exactly how they operate and how they use your product. Taking costs out of your customers' business adds value and allows you to charge higher prices.

Build a brand

Have you noticed how a basic black T-shirt might be $20 in one shop but $50 in another? How can this be? One shop has built a brand making its products desirable and valuable while the other is simply selling a commodity. Those with marketing and sales strategies can build a brand where price is less important.

Beware of discounting

The discounting policies of some businesses seem designed to give away margin without doing anything to promote extra sales. Blanket discounts (e.g. 10 per cent off everything) often fit into this category. Discounting, like all pricing, should be done item by item, with some discounted heavily and others not at all. Keep a firm goal in mind - either the promotion of more sales or clearing dead stock.

Make price setting a central part of your business strategy, always aiming to achieve higher margins. All of your marketing and sales planning should centre on better prices and higher profitability rather than simply increasing sales.

The price of pens

A woman owned a shop that sold, among other things, pens. A box of a new model came in and they were priced and displayed by an assistant using the standard mark-up. However, the assistant misread the invoice, marking up on what was supposed to be the final retail price rather than the wholesale price, and the pens went out for sale at $1.99.

About six weeks later the sales rep from the pen company turned up and was amazed to see the pens displayed and selling at $l.99 instead of the usual 99 cents. They had been selling at double their usual price and they had been selling, too - just as well as if they had been priced at 99 cents. Clearly the price that the market would bear for these pens was at least double their normal price.

Amanda Ellis is an economist who has specialised in international trade and develpoment economics, previously working at the OECD in Paris and the United Nations in Geneva.

Amanda is now Head of Women's Markets and National Manager for Women in Business at Westpac and is dedicated to educating women to become financially independent. For more information regarding your financial issues, please visit www.westpac.com.au/womeninbusiness/ or phone (02)9226 3352.