The price of your product or service tells your customers what to expect in terms of quality and value before they even buy the item. In most people's minds, low-priced products indicate either a bargain or low quality while a higher price often indicates superior value. For example, people have much higher respect and admiration for the high-priced Ritz Carlton Hotel than they do for a Days Inn or Motel 6. The Ritz has actually used its high price as a specific marketing technique to attract an exclusive clientele.

First determine your pricing floor

Where do you start? First, you must know exactly what it costs to make your product or deliver your service. Leave no stone unturned. Factor in all the critical costs such as raw materials, equipment, shipping, staffing and even overtime. Take pains to be as precise as you can.

Once your costs have become crystal clear, determine your desired profit rate. For example, do you want to 5%, 10% or 15% rate of return? After you have made that decision, you will be ready to pit your prices against the competition.

If you have chosen to use price superiority as your driving force, then you must offer unbeatable prices at all times. But be careful not to price yourself so low that you are hardly turning a profit. It boils down to knowing how to keep the costs of your operations low enough to provide an acceptable profit margin. Many small businesses make a critical error by over-burdening themselves with too much overhead. Some naive start-ups actually end up selling their product or service below true cost.

Understand your competition

As much as possible, you should discern how your competitors set their prices and what share of the market they control. If most people perceive your product or service as a commodity, then your pricing plan must take that into consideration. As a rule, commodity items have much less pricing flexibility. If buyers believe that any of your competitors can perform equally well, then your price must also be comparable.

Allow for marketing costs

Think about how you will market your product or service. You must price your product high enough to absorb all related marketing expenses. If your product or service requires extensive advertising, the price structure must take this into account.

A classic example is Orville Redenbacher popcorn, which is priced higher than most brands. It doesn't cost much more to grow corn that pops better, but it does cost a lot to convince consumers that the popcorn really is better. Microwave popcorn is priced even higher because companies can add convenience and simplicity to a list of important benefits.

However, while quality or a similar key benefit is important, you must always be ready to shift your prices downward. Customers can be very fickle. If a comparable or less expensive product with similar capabilities arrives on the scene, you must be ready to adjust. To hang onto your customers, you may be forced to match the new pricing realities.

Pricing a service

Pricing a service follows a few different procedures because the variables are less tangible. Fee-based services in particular are often drastically under-priced because it is so hard to know precisely what those services cost, or what people are willing to pay.

For example, a skilled technician may base fees on how long it actually takes him or her to complete a task. This is not wise because it fails to consider how long it might take the client to do it themselves or how long an "average" technician might need. If it would take a less skilled person two or three times longer, then a great deal of money is being left on the table. Valuable service is being given away.

Another mistake many service providers make is not allowing for overhead like your employees, rent, utilities and travel time when determining fees. Set monthly, weekly and even daily billing goals to avoid underpricing your service. Know exactly how many billing hours it takes to reach your desired profit margin.

Rules of price rounding

Once you have determined your most desirable pricing range, you must begin testing prices for optimal impact. It has long been known that some pricing formats get a far better response than others. So as you work through the testing process, keep the following natural human preferences in mind.

Under $10 - Use endings in 4, 5 or 9.

$10-$25 - Use endings in .95

$25-$50 - Generally use whole dollar amounts ending in 5 or 9, but .50, .75 and .95 are also okay.

$50-$100 - Use whole dollars ending in 5, 7 or 9.

$100-$1000 - Use whole dollars endings in 5, 9 or 95. Avoid pennies.

Over $1000 - Use endings in 100, 300, 395, 500, 595, 700, 795, 900 or 995.