Factors to consider when setting prices

setting prices by valueBack in early May we published a blog on the trade-off between quality, production cost and speed of delivery when negotiating prices with customers.

Now businesses are in potentially more uncertain waters given exchange rate volatility and as yet unknown post-Referendum trading terms, we are looking at pricing from another perspective.

This is about considerations when setting prices that involve both the cost of production, the value of the product to the customer and most importantly making money.

Would you seriously consider selling at a loss?

Loss leaders are a well-known tactic among food retailers, such as selling milk at a loss in order to attract customers into a store, where they will be tempted to buy other items.  It works if a business offers a wide range of products, but why, otherwise would a business do it?

As a tactic for winning work it plainly is not a long term, viable option, and as a strategy for driving competition out of the market it is a very risky gamble.

Essentially setting, or increasing, prices depends firstly on how much the business’ customers value its product and secondly, on what it costs to produce.  If it is highly valued that presents an opportunity to price with a comfortable margin for profit after taking costs into account.

However, there is another factor in the equation and that is the length of time between order and fulfilment, especially when buying in supplies from abroad and when exchange rates are as volatile as they have been since the UK’s EU Referendum in June.

A good example is the recently-confirmed deal to build a new nuclear reactor at Hinckley Point. There, the question was how to set a price for future energy supply that allowed the reactor to be built and for the partners in the deal to be confident of getting a reasonable return from sales, given the lifespan of the project. In this case the uncertainty of cost and price inflation will have been major factors when fixing the minimum future cost of electricity that was highlighted in the media.

This brings up another point to consider and that is who carries the risk when delivery of a fixed price order is a long way ahead.  Should it be the client or the business as supplier?

If the uncertainty of costs is a concern, then forward fixing purchase prices and exchange rates is an option albeit it can be an expensive one. Another option is to include in the contract a variable element that adjusts the price by reference to costs. If this offers customers the prospect that the price may also go down, then it can be easier to sell.

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