Starting a Small Business

Understanding Your Market

Market evaluation is critical and provides the basic data that will determine if and where you can successfully sell your product or service. This process involves defining your goals, scrutinizing your competition and your customer base, and interviewing potential suppliers. The information collected can help you, if necessary, adapt your product or service to better meet customer needs. Market research can help you -

• create primary and alternative sales approaches to a given market,

• make profit projections from a more accurate database,

• organize marketing activities,

• develop critical short- and mid-term sales goals and establish the market's profit boundaries, and

• identify what makes your business different from similar businesses with similar products.

Questions To Ask

Your research should answer these basic questions:

Research on competitors is extremely important. Visit industry trade shows to find out what your competitors are selling and how they are marketing their products. Similarly, stay current on industry magazines and publications.

Market research isn't a one-time activity. Once you establish your business, you should stay in touch with your customers. You may have to adapt your product or service and alter your marketing strategy to keep up with your customers' changing needs.

Pricing Your Products and Services

There are several pricing strategies. Select the approach that will make your goods or services the most competitive and will help you reach your profit goals.

Retail Cost and Pricing

A common pricing practice among small businesses is to follow the manufacturer's suggested retail price. The suggested retail price is easy to use, but it doesn't adequately account for the element of competition.

Pricing Below Competition

This strategy reduces the profit margin per sale. It requires you to reduce your costs and -

• obtain the best prices possible for raw materials or inventory,

• locate the business in an inexpensive area or facility,

• closely control inventory,

• limit product lines to fast-moving items,

• design advertising to concentrate on price specials, and

• limit non-essential services.

One word of caution: pricing goods below the competition can be difficult to sustain because every cost component must be constantly monitored and adjusted. It also exposes you to pricing wars. A competitor can match the lower price, leaving you out in the cold.

Pricing Above Competition

This strategy is possible when price is not the customer's greatest concern. Factors important enough for customers to justify paying higher prices include -

• service considerations, including delivery, speed of service, satisfaction in handling customer complaints, knowledge of product or service, and helpful, friendly employees;

• a convenient or exclusive location; and

• exclusive merchandise.

Price Lining

This strategy targets a precise segment of the buying public by carrying products in a specific price range only. For example, a store may wish to attract customers willing to pay more than $50 for a purse. Price lining has certain advantages:

• ease of selection for customers, and

• reduced inventory and storage costs.

Multiple Pricing

This approach involves selling a number of units for a single price, for example, two items for $1.98. This is useful for low-cost consumer products, such as shampoo or toothpaste. Many stores find this an attractive pricing strategy for sales and year-end clearances.

Cost Factors and Pricing

Every component of a service or product has a different, specific cost. Many small businesses fail to analyze each component of their commodity's total cost, and therefore fail to price profitably. Once you do this analysis, set your prices to maximize profits and eliminate any unprofitable services.

Cost components include material, labor and overhead costs. Material costs are the costs of all materials found in the final product, such as the wood, glue and coverings used in manufacturing a chair.

Labor costs are the costs of the work that goes into manufacturing a product. An example would be the wages of all production-line workers producing a certain commodity. The direct labor costs are derived by multiplying the cost of labor per hour by the number of personnel hours needed to complete the job. Remember to use not only the hourly wage but also the dollar value of fringe benefits. These include social security, workers' compensation, unemployment compensation, insurance and retirement benefits.

Overhead costs are those not readily identifiable with a particular product. These costs include indirect materials, such as supplies, heat and light, depreciation, taxes, rent, advertising, transportation and insurance. Overhead costs also cover indirect labor costs, such as clerical, legal and janitorial services. Be sure to include shipping, handling and/or storage as well as other cost components. Part of the overhead costs must be allocated to each service performed or product produced. The overhead rate can be expressed as a percentage or an hourly rate. It is also important to adjust your overhead costs annually. Charges must be revised to reflect inflation and higher benefit rates. It's best to project the costs semiannually, including increased executive salaries and other costs.

Next Page:
Understanding Cash Flow
What Lenders Look For

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