How to Price a Product? A Simple Guide for Merchants
It’s crucial to price your products as it has an impact on almost all aspects of your business. Your pricing is a vital factor in your cash flow, profit margins, and even spending you can afford to cover.
Therefore, it’s quite easy to struggle with pricing when you’re running a new store or cranking out a product - even before you create product descriptions - but it’s significant not to let the decision prevent you from launching.
In this post, I’d like to take you through How to Price a Product? A Simple Guide for Merchants in 2020. The best pricing documentation you can receive is from introducing and testing with real clients - but you still have to begin somewhere, with a price that will work.
Table of contents
- What is product pricing?
- How to price a product?
- How to price a product for retail?
- Which factors to consider when pricing your products?
What is product pricing?
Regardless of what product you sell, the price you set will be a deciding factor on your business’s success. Although pricing strategies can be difficult, the basic rules of pricing are quite clear:
- All prices must include costs and profits.
- The most efficient way to reduce prices is to reduce costs.
- Review prices regularly to ensure that they reflect the dynamics of cost, market needs, response to the competition, and profit goals.
- Prices must be set up to assure sales.
To establish a price for your goods, you need to know the costs of running your business. If the price for your products or services doesn’t include costs, your cash flow can be negative, you will waste your financial resources, and your business will eventually fail.
To know how much it costs to operate your business, you’ll need to cover property and equipment leases, financing costs, utilities, inventory, loan repayments, and salaries/ commissions. Remember to include the costs of markdowns, costs of goods sold, expected profits, shortages, employee discounts, and damaged merchandise to your running spending.
It is also essential to cover profit in calculating costs. Consider profit as a fixed cost, such as a loan payment or payroll, because nobody does business to break even.
As it needs time and market research to go to pricing decisions, business holders plan to establish prices once and “hope for the best.” Nevertheless, it is hard for such a policy to get profits.
What is the most appropriate time to review your prices? Do so if:
- You launch a new item or product line;
- Your costs change;
- You choose to join a new market;
- Your competitors adjust their prices;
- The economy witnesses recession or inflation;
- Your sales strategy changes;
- Your clients are earning more money due to your goods or services.
Generally, prices are set in one of the four following ways:
Many manufacturers choose to use cost-plus pricing. To succeed with this method, you’ll need to ensure that the “plus” number includes all overhead and drives the percentage of profit you need. If your overhead figure is inaccurate, profits you can get are too low.
Demand price is identified by the optimized combination of volume and profit. Goods are often sold through various sources at various prices - wholesalers, retailers, direct mail marketers, or discount chains - are examples of products whose price is defined by demand. A wholesaler may purchase greater bulk than a retailer, which leads to buying at a lower unit price. The wholesaler gets more profits from a larger amount of sales of an item priced lower than that of the retailer. The retailer pays more for a unit as he or she cannot buy, stock and sell as several items as a wholesaler does. This explains why retailers charge higher prices to consumers. Demand pricing is complex to grasp as you must precisely calculate beforehand what price will create the optimized relation of profit to volume.
Generally, competitive pricing is chosen when there’s a market price established for a specific item or service. If your competitors are setting $100 for a replacement windshield, for instance, that’s the price you had better charge. This pricing method is often used in markets with commodity goods, which are hard to differentiate from another. If a big market player, usually known as the market leader, will establish the price that other smaller organizations in the same market will be forced to follow.
To implement competitive pricing efficiently, get to know the prices each competitor has set. Then find out your optimum price and make decisions, according to direct comparison, if you can defend the prices you’ve established. If you want to charge more than your competitors, you will have to create a case for a higher price, like offering a professional customer service or guarantee policy. Before going to the last commitment to your prices, ensure that you understand the level of price awareness within the market.
If you choose competitive pricing to define the fees for a service business, remember that unlike a situation where some firms are selling the same items, services vary from one company to another. Consequently, you can set a higher fee for superior service and still be constituted competitive in your market.
Retailers, wholesalers, and manufacturers often use this type of pricing. Markup is defined by including a set amount cost of an item leading to the price charged to the consumer. For instance, if the cost of the item is $100 and your price is $140, the markup will be $40. To figure out the percentage markup on costs, let’s divide the dollar amount of markup by the dollar amount of item cost.
This pricing often confuse - not to mention lost profits - among numerous small emerging business holders is often mistaken with gross margin.
How to price a product?
Know the basic pricing strategies in your industry
One of the easiest ways to set the price for your product is cost-plus pricing.
Cost-based pricing includes calculating the total costs it needs to make your goods and then adding a percentage markup to define the last price.
For instance, given that you’ve created a product with the costs below:
- Material costs = $20
- Overhead = $8
- Labor costs =$10
- Total costs =$38
Then you include your markup percentage, for example, 50%, to the total costs to bring you the last product price of $57.00 ($38 x 1.50).
This sort of pricing is easy, quickie, and allows you to add a profit margin to any item you’re going to sell.
As a competition-based pricing method, market-oriented pricing is to compare the same products in the market.
The merchant establishes the price higher or lower than their competitors, which depends on how well their own item matches up.
Price above market: Pricing your item above the competition to brand yourself as having a higher quality or better-performing product.
Copy market: Selling your product at a similar price as your competitors to gain the most profit while being competitive Price below market: Using data as a standard and pricing an item below the competition, to attract consumers to your store over theirs.
Each strategy in the market-oriented model has its advantages and disadvantages. With this pricing method, it’s crucial to know the costs of making your product and the quality in comparison with competitors to precisely your product.
Dynamic pricing, also known as demand pricing or time-based pricing, is a strategy for businesses to establish flexible prices for an item or service according to current market needs.
Dynamic pricing is the act of changing a price many times throughout the day, week, or month to better fit customer buying habits.
Numerous amazing software products can help you to use dynamic pricing for your goods automatically.
- Tool #1: Quicklizard
- Tool #2: Omnia Retail
- Tool #3: Profit Peak by Spitly (Amazon-specific)
These great tools enable you to create certain pricing guidelines by aiming at specific margins to help your eCommerce business stay profitable.
How to price a product: Step-by-step guide
Step 1. Add up your variable costs (per item)
Firstly, you need to know all the costs related to getting each item out the door.
If you order your items, you’ll have a clear answer as to how much each unit costs you, which is your cost of goods sold.
If you make your products, you’ll have to do some research and look at your raw materials. What is the cost of these materials and how many items you can make from it? That can bring you an overall estimate of your cost of goods sold per product.
Nevertheless, the time you invest in your business is also important. In order to price your time, let’s have an hourly rate you’d like to earn from your business, and then divide that by the number of items you can create in that amount of time. To have a sustainable price, ensure to include the cost of your time as a variable item cost.
Step 2. Add a profit margin
When you have a total number for your variable cost per item sold, the next thing to do is to add profit to your price.
Given that you wish to get a 20% profit margin on your goods beyond your variable costs. When you want this percentage, there are two things to remember:
- You have not added your fixed costs, so you will have costs to include on top of just your variable costs.
- You necessarily observe overall market, and ensure that your price with this margin stays within the overall “acceptable” price for your market. If you double the price of all of your competitors, your sales may become difficult, depending on your item category.
It’s time to calculate a price. Let’s divide your total variable costs by 1 minus your expected profit margin, shown as a decimal.
Target Price = (Variable cost per product) / (1 - your expected profit margin as a decimal)
Step 3. Don’t forget fixed costs
Keep in mind that variable costs are not your only costs.
No matter what, you still have to pay fixed costs which stay unchanged if you sell 10 items or 1000 items. They’re a crucial part of operating your business, and the target is that they’re covered by your product sales.
As you choose a per-unit price, it can be hard to find how you fixed costs match to. An easy way to do this is to take the data about variable costs you’ve collected, and then set them up in the break-even calculator spreadsheet. If you want to edit the spreadsheet, click on File, and make a copy to have a duplicate that only you can access.
It’s created to consider your fixed costs and your variable costs in one place, and to figure out how many units you will need to sell of a single item to break even at your price. Thanks to these calculations, you can decide the balance between including your fixed costs and establishing a competitive and manageable price.
How to price a product for retail?
A lot of retailers assess their pricing decisions by using keystone pricing, which is necessarily x2 the cost of the goods to establish a healthy profit margin. Nevertheless, in several examples, you may want to mark up your items lower or higher, depending on your certain situation.
This is a simple formula to calculate your retail price:
Retail Price = [(Cost of item) ÷ (100 - markup percentage)] x 100
For instance, you wish to price an item that costs you $15 at a 45% markup rather than the usual 50%. Then you would calculate your retail price:
Retail Price = [(15) ÷ (100 - 45)] x 100 Retail Price = [(15 ÷ 55)] x 100 = $27
Manufacturer suggested retail price
The Manufacturer suggested retail price (MSRP) is the price a manufacturer suggests retailers use when selling an item. Manufacturers initially began using MSRPs to standardize multiple prices of items across various locations and retailers. Retailers often choose to use the MSRP with highly standardized goods, such as electronics and gadgets.
- Advantages: When retailers use the MSRP to price their products, they can save some time for themselves.
- Disadvantages: Using the MSRP makes it impossible for retailers to compete on price. With MSRPs, retailers in a specific industry tend to sell that product at the same price.
This pricing strategy means that a retailer will x2 the wholesale costs they spent on a product to define the retail price. There are a variety of cases where the price of an item using keystone pricing may be too high, too low, or just appropriate for your business.
If you have goods that have a slow turnover, have considerable shipping and fulfilling costs, and are rare and unique in some aspects, you might sell yourself short with the keystone pricing method. In those cases, a retailer can use a higher markup formula to raise the retail price for these in-demand items.
Meanwhile, if your goods are relatively commoditized and popular, it can be challenging to pull off keystone pricing.
- Advantages: It is easy and quick to implement the keystone pricing strategy and gain a health profit margin.
- Disadvantages: According to the availability and the need for a specific item, it might be illogical for a retailer to markup an item that high.
It’s easy for us to see this pricing strategy in grocery stores or apparel stores, particularly the ones selling socks, t-shirts and underwear. With this method, retailers can sell more than one type of product for a price.
- Advantages: Retailers use this tactic to make a higher perceived value or a lower cost - which can eventually result in generating larger volume purchases.
- Disadvantages: When you bundle items up for a low cost, you’ll face difficulty selling them individually at a higher cost, leading to cognitive dissonance for customers.
Penetration pricing and discount pricing
It’s undeniable that consumers love coupons, sales, rebates and seasonal pricing. That’s the reason why discounting is the most popular pricing method for retailers at all sectors.
Discount pricing brings several benefits, such as growing foot traffic to your store, decreasing unsold inventory and appealing a more price-conscious group of consumers.
- Advantages: The discount pricing strategy works for appealing a larger amount of foot traffic to your store and removing out-of-season or old inventory.
- Disadvantages: If you use this strategy too often, you may get a bad rap of being a bargain retailer. That could stop customers from buying your products at regular prices.
Penetration pricing is an effective marketing strategy for new businesses. A lower price is temporarily used to launch a new item to achieve market share. A lot of new brands are ready to make the tradeoff of additional profit for consumer awareness to get their foot in the door.
With this strategy, retailers lure consumers with an expected discounted item and then stimulate customers to purchase additional products.
For example, a grocery store decreases the price on peanut butter and promotes complementary products such as bread, honey, or jam. The grocer may provide a special bundle price to stimulate consumers to purchase these complementary products instead of just selling a jar of peanut butter. The original product may be sold at a loss while the retailer gets benefits from the other items.
- Advantages: This tactic can be beneficial for retailers. Stimulating consumers to purchase many items in one transaction increases overall sales per shopper and can cover any profit loss from decreasing the price on the original item.
- Disadvantages: If used too often, shoppers might expect bargains and will not be likely to pay the full price.
According to research, as sellers spend money, they’re experiencing pain or loss. Therefore, it depends on retailers to reduce this pain, which can boost the likelihood that consumers will purchase. Traditionally, retailers have done this with prices ending in an odd number like 7 or 9. For instance, a merchant would price an item at $6.99 rather than $7.
- Advantages: Charming pricing enables merchants to create impulse purchasing. Setting prices ending with an odd number can make buyers think that they have a deal.
- Disadvantages: If you sell luxury products, reducing your price from a whole number like $1000 to $999.99 can impact your brand’s perception. This tactic can give luxury consumers the impression that the items are defective or are market down for the same reason.
Competitive pricing means using competitor pricing information as a standard and consciously pricing your goods below theirs. Outpricing your competitors can encourage price-conscious consumers to buy your items over similar ones. Nevertheless, this “race to the bottom” is not always the most effective strategy for all businesses and products.
- Advantages: This tactic works well if you can discuss with your suppliers to have a lower cost per unit whereas decreasing costs and actively promoting your pricing.
- Disadvantages: This can be challenging to sustain as you are a small retailer. Lower prices lead to lower profit margins, so you need to sell higher volume than competitors. It depends on the items you’re selling, consumers might not always go for the lowest-priced product on a shelf.
Brands assess their competition but consciously price items above theirs and brand themselves as exclusive or luxurious. For instance, a high price is effective in Starbucks’s favor as customers choose them over a lower-priced competitor like Dunkin’ Donuts.
- Advantages: This pricing method can have its “halo effect” on your business and goods. Shoppers perceive that your goods have better quality because of the higher price compared to other brands.
- Disadvantages: It can be hard to use this pricing strategy, which depends on your store’s locations and target consumers. If consumers are price-sensitive and have some other choices to buy similar products, the strategy won’t work. This is the reason why it’s significant to understand your target shoppers and conduct market research.
Anchor pricing is another psychological pricing strategy merchants use to make a favorable comparison. Specifically, a retailer sets both a discounted and the regular price to create the savings a customer could get from making the purchase.
- Advantages: If you place your regular price as much higher than the discounted price, it can affect a consumer to purchase according to the perceived deal.
- Disadvantages: If your anchor price is not realistic, it can result in a loss of trust in your brand. Shoppers can check prices online against your competitors - so make sure your prices are reasonable.
Which factors to consider when pricing your products?
Know your customers
It is critical to do some market research to understand your customers. This sort of research can vary from informal surveys of your current customers by sending emails with promotions to the more extensive research projects done by third party consulting companies. Market research companies can discover your market, divide your potential consumers by demographics, what they purchase, and so on. If you don’t want to invest in market research, you can look at customers in terms of some groups - the budget sensitive or the convenience focused. Then find out which group you’re aiming and price accordingly.
Know your costs
It’s important to know how much your product costs, how much you’ll need to mark up the product and how many you need to sell to earn a profit. Keep in mind that an item’s cost is more than the literal cost of the product because it covers overhead costs. Overhead costs may consist of fixed costs such as rent and variable costs like shipping or stocking fees. You must add these costs to your estimate of the real cost of your goods.
Many businesses don’t consider all their costs and under price or consider all their costs and expect to earn a profit with one item and overcharge. It’s suggested making a spreadsheet of all the costs you have to cover each month, including the following:
- Your actual product costs, which include labor and the fees of marketing and selling these items.
- All of the running expenses needed to own and run the business.
- The costs related to borrowing money (debt service costs).
- Your salary as the manager of the business.
- A return on the capital you and other shareholders have spent.
- Capital for future development and replacement of fixed assets as they’re old.
Know your revenue goal
You had better have a revenue goal for how much of a profit you wish your business to gain. Take that revenue goal, consider your costs for manufacturing, marketing and selling your item and you can set a price per item. If you only sell one item, the process is so easy and simple. Estimate the quantity of units of that item you expect to sell the following year, then divide your revenue goal by the quantity of units you expect to sell and you come up with the price at which you have to sell your item so as to gain your revenue and profit targets.
If you’re selling a variety of products, allocate your overall revenue goal by each product. Then follow the same steps to have an appropriate price.
Know your competition
It is also essential to make a head-to-head comparison of your goods’ price to your competition’s products. You need to compare net prices, not simply the list price. This information can come from secret shopping, publishes data and so on. Take notes during this process about how your business and goods - and the competition - are perceived by the market.
Know where the market is headed
You are able to track outside factors that will affect the need for your product in the coming time. These factors can be something like long-term whether patterns to laws that may have an impact on future sales of your goods. You also need to consider your competitors and their actions.
The article has provided you with the knowledge on Pricing a Product and offered some common pricing strategies for retail businesses so that you can make a more informed decision. Not every pricing tactic will be useful for every type of retail business - every brand will have to do their homework and find out what works best for their goods and target consumers.
If you have any questions or concerns, let us know in the comment section. Thank you for reading!
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