How To Price A Product
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The price you set for your products and services is a vital part of your marketing strategy. “It’s probably the toughest thing there is to do,” says Charles Toftoy, associate professor of management science at George Washington University. “It’s part art and part science.” There’s no one right answer. Set a price that’s perceived as being too high and potential buyers may pass you by, thinking your product is too expensive. Set a price that’s too low and, not only will you make less money, but your potential customers may think that the quality of your product is inferior. How do you find that “sweet spot” between a price that’s too high and one that’s too low? We’ll walk you through the process and what you need to know to make smart pricing decisions.
Why pricing is important
Too often retailers, especially e-commerce retailers, leave pricing their products until the last minute, right before they are ready to load their products on their website or sales platform. In fact, pricing is almost an after-thought to many retailers. Many set prices based on what their competitors are doing or, worse, what they think the price should be. Few do the research that’s necessary to arrive at the truly optimum price.
Pricing is important for a number of reasons. First, it sets the foundation for how much money your company will make. Keep in mind that even a small variation in pricing can have a big impact on your bottom line. For example, if you sell 10,000 units per month and increase your pricing by just $1.00, that adds another $10,000 to your monthly revenue without adding dramatically to your costs.
Another reason pricing is important relates to your brand image. Pricing is a big factor in how consumers perceive your company and your products. Lower priced items are thought to be less durable and of lower quality, but more of a bargain than higher-priced items. Conversely, higher-priced items are perceived to have a greater, lasting value, to offer more prestige and to be more of a luxury item. Finding the right balance can be tricky. If you are looking to set yourself up as a luxury brand, you’ll want to err on the side of higher prices. On the other hand, if you want your brand to be about having the lowest prices, you’ll want to price accordingly.
Just as you do with your marketing plan, you need to have a long and short-term strategy with your pricing. You also need to set a goal. Ask yourself, do you want to maximize profit? Do you want to enter a new market and establish yourself as a “player” in the industry? Or maybe, you want to lure customers away from your competitors and allow them to sample your quality products and excellent customer service so that, hopefully, they will continue to buy from you even when you raise your prices. Whatever your plan, you need a specific, well-conceived goal, ideally written down, before you start pricing your products. As your business grows, you’ll want to revisit your pricing goal at least quarterly. For instance, let’s say you launched your business with relatively-low prices. After you have established a good customer base, you may want to switch your goal from acquiring a large number of new customers to maximizing the profit from each item.
The psychology of pricing
While covering your costs and making a reasonable profit are certainly important when setting your pricing, there’s more than just numbers involved to how customers view your prices. The so-called psychology of pricing refers to how customers perceive and react to your pricing, whether they view your products as a good deal or over-priced, whether they see value in your products and/or whether they view them as luxury items. And, of course, whether your pricing compels them to make a purchase. “Entrepreneur” magazine defines the psychology of pricing as “a pricing/marketing strategy based on the theory that certain prices have a bigger psychological impact on consumers than others”. We’ll talk a little more about this in the next section.
Different methods of pricing
There’s no one best way to price your products. In fact, the best pricing strategy is usually to combine several different pricing methods. There are a myriad of different pricing methods. Below are just a few of the ones we think you should consider.
1. Cost-based pricing.
Using cost-based pricing is, arguably, the easiest way to set your pricing, although it may not be the most effective. To arrive at a price using the cost-based pricing method, you add up all of the costs associated with making/acquiring the item as well as your marketing costs and a percentage of your overhead. You then multiply that number by the amount of mark-up you want to take and add that to the cost. (The average in retail is 50 percent.) For example, if your cost to produce or acquire an item is $40 and your mark-up is 50 percent or $20. Add those two figures together for a price of $60. Sometimes, you’ll hear this strategy referred to as “keystone pricing”. Strictly defined, this is when the retailer doubles the total cost of an item to arrive at a selling price.
Another form of cost-based pricing is MSRP-based pricing. Depending on what you sell, the manufacturer of your product may set a “manufacturer suggested retail price” (MSRP) on the item. This price is set at a rate where both you and the manufacturer can make a profit. Sometimes, you are bound by contract to not sell the products at a lower price. More often, you are able to set your own pricing, but the price you pay the manufacturer for the item is still based on the MSRP, so by cutting the price, you cut into your profit margin.
While cost-based pricing is certainly easy, it’s generally not the best strategy, at least not for 100 percent of your products. If your brand is such that customers expect low prices from you, then they may be disappointed in the 50 percent markup. One the other hand, if you have products that are “flying off of the shelves”, you may be robbing yourself of potential profit, since customers are likely to spend more for such a high-demand items.
2. Market-based pricing.
Many retailers think that they have to have the lowest price in the market to be successful. This can be a dangerous policy and cause you to lose money and cause your customers to buy from you only for price, not quality or service. E-commerce guru, Seth Godin, famously said, “The problem with the race to the bottom is that you might win. Even worse, you might come in second.” Price wars usually end with both parties making little or nothing off of each sale.
Another type of market-based pricing is comparing your pricing to that of your competitors for your customer to evaluate. This includes advertising your prices alongside of your competitors or marketing your products with phrases like “lowest prices in the county”.
3. Bundle pricing.
Bundle pricing is when you include more than one product for a single price. A good example of this is the telecommunications companies that combine cable television, internet access and phone service for a single price. Another example is gift baskets, where multiple items are combined for one “basket” price. Bundle pricing is a good way to differentiate your company from your competitors and avoid going “head to head” in a price war. Bundle pricing also reduces the number of individual items you have to set prices for. This type of pricing can be very effective and encourage your customers to view your products as having more value than those of your competitors.
4. Dynamic pricing.
Dynamic pricing refers to pricing that changes or is only available for a limited time period. This category includes things like flash sales, inventory-reduction sales and limited time offers.
- Anchor pricing. Anchor pricing is when you set a price that you feel the product is worth, not necessarily based on your cost. This is often used as a starting point in businesses where negotiation is common, such as car dealers and antique stores. This allows the customer to think he or she is getting a deal by paying less than the stated price.
- Loss leader pricing. Loss leader pricing is when you deliberately set your price below what it costs you to buy or produce the item. Grocery stores sometimes use this technique to get customers to come to their store where the customers will (likely) purchase additional items. Black Friday sales often feature loss leader pricing for a limited number of items available for a short period of time, again to encourage shoppers to visit their store. While this method of pricing can be very effective, you obviously want to be careful with it, since every purchase at these prices loses money for your business.
- Market pricing. Market pricing is a form of dynamic pricing where products are marked up only to be discounted later. This generally happens when stores offer 50 percent off all merchandise or a similar offer. Department stores sometimes use this type of pricing, with offers like 25 percent off of all shirts of a certain brand.
- Discount pricing. Unlike market pricing, with discount pricing, you set a low price initially, either from a set time or permanently. This pricing philosophy is a good idea when you have a lot of product you need to sell in a short period of time, such as when you want to qualify for a manufacturer’s bonus, right before you take inventory, or before you move to a new location. Discount pricing also include offers like BOGO (buy one, get one free) or variations of that theme. The potential danger with using discount pricing too often is that your customers may only want to buy from you when you are offering a discount.
5. Value-added pricing
Value-added pricing is when you sell your item at full price, but offer something with it. For example, Amazon offers free shipping for customers who order at least $25 worth of (qualifying) merchandise. The company claims that one move was responsible for allowing the company to compete with bricks-and-mortar stores in its early years. Since consumers generally don’t want to pay for shipping, they are less likely to buy from a retailer that charges shipping. Other examples of value-added pricing include offering something free with a purchase, such as a free gift, free car wash or free gift wrap during the holiday season.
However, offering a product or service on top of your product item doesn’t mean that you have to offer it for free. You can make your offer a discount on something, such as a second item, or you can add in the cost of the “free” product or service when you are figuring your product costs and, thus, spread that cost among all of your items.
6. Charm pricing
So-called charm pricing is the practice of formulating your prices so that they appeal psychologically to the customer. This is most often illustrated by ending prices in a 9, such as pricing your product at $24.99 instead of $25. The opposite of charm pricing is prestige pricing. This refers to the theory that a $100 item will be perceived as being more of a luxury item than a $99 item.
After reading above all of the different types of pricing, you probably saw some types of pricing that you feel would work for your business and a few that you could definitely eliminate. That’s good, because you’ll generally want to use a mixture of pricing strategies to price the items in your store.
The best pricing is fluid
No one ever said that once you set your price, you can never change it. In fact, we think that the best pricing policy is fluid changes as market conditions, seasons and demand shift. That’s why a pricing plan is important. It’s wise to draw out your annual pricing plan at the same time you set your marketing plan down in writing. The two go hand in hand. Of course, you also want to be flexible enough to react to your customers’ input, competitor pricing and unanticipated market changes.
Testing your pricing is important to making sure that your pricing stays on point, especially on your new items. Says Laura Willett, a small business consultant and faculty member in the finance department at Bentley College in Waltham, Mass, “The best way to determine if the product is being priced correctly is to watch sales volumes immediately after making any change. If a price increase is too high, customers will react pretty quickly. Also watching the competition can help – if you’ve made a positive change in prices; competitors are likely to follow suit.”
Tips for setting optimal prices
1. Make sure that your costs are covered. Only in very rare circumstances, such as with loss leader pricing, do you want to price your products lower than your costs. However, it’s a common mistake to only factor in your manufacturing or wholesale costs of a product when setting a price and not all of the related costs. Other factors should also be included in setting your costs, things such as your overhead, your salary (and those of your other staff), utility bills and the interest and fees associated with any loans you may have taken out to purchase your inventory.
2. Model, but don’t copy your competitors. Keeping an eye on what your competitors are doing with their pricing is a good idea and smart business. However, you don’t want to duplicate what they are doing. You want to make sure that your products and your company are perceived by customers are being different from your competitors. Even if you are selling the same products, it’s important to market them in such a way as to be at least slightly different. Maybe your packaging is different or you offer free delivery.
3. Don’t assume all customers are looking only at price. Too many retailers assume that price is the only thing that matters to your customers. Says long-time business consultant Lawrence L. Steinmetz, co-author of “How to Sell at Margins Higher Than Your Competitors:Winning Every Sale at Full Price, Rate, or Fee”,”The first thing you have to understand is the selling price is a function of your ability to sell and nothing else. What’s the difference between an $8,000 Rolex and a $40 Seiko watch? The Seiko is a better time piece. It’s far more accurate. The difference is your ability to sell.”
4. Keep it simple. Complicated pricing formulas might make sense to you, but they can quickly turn off your customer. This might include pricing with different tiers or pricing where the discount grows the longer the item remains unsold in the store. Even how you write your pricing should be as simple as possible. Studies, including one by the “Journal of Consumer Psychology”, have shown that even pricing your product as $25.00 is less appealing than pricing it at $25 and that 25 is more attractive than $25.
5. Make the most of seasonal impact. The season can have a big impact on the demand for products and thus your pricing. For example, consumers are willing to pay more for roses around Valentine’s Day or kayaks in the beginning of warm weather season than they are other times of the year. Conversely, American consumers except to get a deal the weekend and Monday after Thanksgiving, the traditional time for Black Friday and Cyber Monday sales.
Pricing your products doesn’t have to be an impossible task. To be successful with your pricing, make sure to have a written plan, make your pricing easy for consumers to understand, take into account market changes and seasonal differences and keep an eye on what your competitors are doing.