When businesses seek to boost profits and maintain growth, they often concentrate on increasing volume or lowering costs but neglect the role that pricing plays. However, the importance of price optimization shouldn’t be underestimated, and may be the most cost-effective way to increase business profits.

Price optimization requires understanding the true value of your product and that value is a reflection of what your customers are willing to pay. Simply put, if you overvalue your product, your sales will suffer and if you undervalue it, you’re throwing money away. Therefore, the trick is knowing the maximum price that your customers are willing to pay.

A good pricing strategy will help your business resist market-driven competitive pressures by generating extra worth out of your products and services. Understanding what most small businesses do wrong is the first step to successful price optimization.

Here are 5 common mistakes that many SMEs make when it comes to pricing.

1. They base prices on costs instead of value.

The vast majority of businesses still determine prices by working out the total cost of a product and then adding on their profit margin. However, this reflects a misunderstanding of how value works in the equation. If the cost-based price is higher than the value perceived by the customer, sales will slow and profits suffer. Conversely, if your cost-based price is lower than customer-perceived value, you’re missing out on potential profit.

2. They don’t segment customer pricing.

Different customers will value your product in different ways. Some may be willing to pay more and others less, depending on what the product is uniquely worth to them. Your pricing plan should reflect this with different prices for different customer segments. Tailor your product for each distinct segment through repackaging, targeted marketing, different delivery options and other variables.

3. They add the same profit margin, regardless of product.

Segmenting your products and services follows the same principle as segmenting your customers. The price you assign to different products should reflect how a particular customer values a particular product. Understanding the intrinsic value rather than focusing on a fixed profit margin will help you make necessary pricing adjustments to maximize profitability.

4. They don’t know who their most profitable customers are.

It’s a rule of thumb for most businesses that 4/5th of profits are generated from 1/5th of customers. However, most small businesses aren’t good at identifying who that top 20% is and spend a disproportionate amount of time on lower-yielding customers. Find out who your most profitable customers are and invest more time in holding on to them.

5. They don’t raise prices when necessary.

Many businesses put off making necessary price increases because they worry about the impact on sales. However, you should condition your customers to expect such periodic price adjustments, especially if you are adding value by making improvements to service.

Compared to costs like marketing and advertising, investing in price optimization is a cheap and effective way to increase your profits and secure the long-term success of your small business finances.