Pricing your product is one of those decisions that’s guaranteed to cause stress. Entrepreneurs go round and round wondering what to do, and even once a decision is made, the price rumination keeps going.
Although the constant obsessing about price may be stressful, it can also be useful. No product’s price can stay the same forever, and experimenting with different prices allows you to get real data about how much people will pay for your product.
Every product’s price journey is different. Depending on your industry, region, competition and many other factors, you’ll have to make educated guesses about where to start and how to pivot. However, there are a few principles that are the same for every business, and it’s helpful to learn about all the pricing strategy options before you decide which direction to go in.
Note for the math phobes: pricing is one part of your business where someone with good ‘math eyes’ needs to be involved. Don’t try to price on your own if you aren’t comfortable with arithmetic, fractions, percents, etc. Even if your business is just you, reach out to a friend and have them help you with this part. If you’re completely lost and need some extra professional help, consider hiring a sales rep.
Where all pricing begins:
Calculating Your Costs
There are many different pricing strategies, but they’re all tied together by the same principle. You’ve got to understand your costs fully. There’s no getting around it, price is all centered around costs, because of the basic principles of doing business.
Businesses need to make money to survive
- Businesses cost money to run, and they earn money by providing goods and services.
- In the long term, businesses need to make more money than they spend, or they’ll go out of business.
To calculate how much money you need coming in, you have to calculate how much money you have going out.
Start by finding your fixed and variable costs. Fixed costs are expenses that do not depend on the number of goods or services being made by the business.
Examples of fixed costs are:
- Salaries (if people are working whether or not you’re busy)
You’ll also need to find your variable costs. Variable costs are volume related, if you make a lot of product one month your variable costs will be higher.
Examples of variable costs are:
- Raw materials
- Salaries (if people only work when product is being made)
Once you have a comprehensive list of your costs, it’s time to research different pricing strategies and see which ones seem like a good fit for your industry and company. Even though only a few strategies may be relevant for your company, it’s worth familiarizing yourself with several of them so you can make an informed decision about which is best.
Cost-Plus Pricing is the simplest type of pricing. After you know what it costs you to sell one unit of your product, you decide what percent profit you want, make a calculation, and you have your price.
If you sell t-shirts that cost you $11 each to make and decide to use a 45% markup, here’s what your pricing would look like:
This pricing strategy is simple and commonly used, but has some criticisms and is sometimes considered too simple. According to cost-plus pricing, if your company finds a way to cut costs, you should lower your price. It also makes your company more profitable the higher your price is since even though your percent markup is the same, the profit is a bigger overall number. Cost-plus pricing also doesn’t incorporate any of your competition. If your costs are too high, your price will be too high to compete.
The best thing about cost-plus pricing is that it’s simple and safe. If you’re charging more than you’re spending by a safe margin, your numbers will have more of a tendency to be reliable and predictable.
The other standard method of pricing is value-based pricing. Value-based pricing is where the guiding philosophy is to price things based on what the perceived value of the item is, instead of the cost.
This strategy really only works if the perceived value of your product is much higher than your costs. A cynical way of thinking about value-based pricing is to think of it as charging as much as you possibly can.
Value-based pricing is often based on emotions and social expectations. A piece of fine art that sells for $500,000 may only have cost $1,000 in raw materials. Paying $35 for an Apple brand charger versus $9 for the same thing on Amazon is another example of how one brand gives emotional fulfillment that another does not.
To decide if value-based pricing is right for you, consider your brand and your industry. What’s the range of prices for your category of product currently out there? If you’re selling hammers, you’re going to have a hard time using value-based pricing. Most hammers are between $2-$30, and purchasing a hammer doesn’t have a lot of emotions behind it.
If you’re selling t-shirts, however, the sky’s the limit. You can buy t-shirts from $2 to a diamond-encrusted $400,000.
Competitive pricing is when you look at your competitors and decide to base your price off their price. When participating in competitive pricing, you have three options. You can set your price lower, higher, or equal to the competition. Each one of these options implies something different to your customers and helps them determine what emotions they should have about your product.
If you set your prices to roughly equal to the competition, you’re telling people they should consider your product about the same as the competitors. If your competitors have a specific brand aesthetic and reputation, you’re signaling that your company is in the same category. To gain even more of an edge, find a way to differentiate your product as better, despite the same price tag. If you’re able to include something like ‘20% more’ or ‘Made in the USA,’ you’re giving people a reason to choose you.
By pricing yourself lower than the competition, you’re establishing yourself as the better option for budget-conscious shoppers. While the lower price tag may be enough to get sales, you should still try to match your brand and packaging to your competitors. You can inspire people to ask themselves, ‘Why would I buy this more expensive one?’ If they can’t answer the question, they’re more likely to go with you.
If you price your product higher than the competition, you’re indicating your product is better and deserves to cost more money. This can be a great differentiator, as long as you provide a reason you cost more. Also, if you’re going to stand out of the crowd by costing more, you better make sure your packaging is on point. Make sure it emanates class and quality so that people can justify spending more.
Dynamic pricing, otherwise known as surge pricing, demand pricing, or time-based pricing, is where you change your price depending on current market demands.
If your product or service is dependent on the time of year, month, week, or even day, you might want to consider dynamic pricing.
Dynamic pricing is the reason resorts are cheaper in the winter, and why September 11th is the cheapest day to get married.
Retailers also engage in dynamic pricing; Amazon changes its products every 10 minutes. They use the data to stay competitive and to find what prices will make you click the ‘buy now’ button.
If you need to get rid of inventory and increase customer traffic and sales, discount pricing might be right for you.
The benefits are clear; people love discounts. If you offer reduced prices, you’ll generate customer excitement and positive emotions, spread word of mouth, and get more revenue. The problem, just like all good things, is that it can’t go on forever.
Use discounts to boost your business temporarily, but most of the time sales prices are not sustainable in the long term.
If you choose only to discount a few of your most popular items, you’re essentially participating in loss leader pricing, which is another viable strategy.
Loss Leader Pricing
Wow! A brand new printer for only $34.99? What a great deal!
*3 months later*
Whoa! The ink cartridges are $21.99 each, and I need a black, blue, red, and yellow one? What a rip off!
When businesses purposely make almost nothing, nothing, or actively lose money during a sale, they’re participating in loss leader pricing.
Loss leader pricing has two main techniques. One, like the printer example, is to sell you something that will need additional parts or replacements later on, and they’ll be marked way up. Razors are often sold at a loss, but you better believe they get their money back on the razor blades.
The other way to use loss leader pricing is to lose money on a single popular item, with the anticipation that most people will make additional purchases of other items. Milk and eggs in grocery stores are often sold at close to a loss because they know you’re not just going to come in for those two items.
They’ll also place the milk and eggs in the back, so you have to walk through the rest of the store and see everything else you could buy as you’re making your purchase.
If you have an item that needs refills or one very popular item and a collection of other products with higher profit margins, loss leading may be a good choice.
At the end of the day, only you will be able to tell which pricing strategy is right for you. And honestly, you may not know which one is right until you try out several and see what results you get.
Don’t view your price as a one-time decision that gets made before you have any data. Start with your best guess, research and experiment with different options, and narrow your strategy as you find out what give you good results.