Methods to Price Your Products
What was the last thing you bought? For me it was a pair of jeans. When I was considering buying them I took a couple of things into account. One was price, another was need, and a third was quality.
Those are the basic principles we use to determine if we should buy something. Those are also the same principles I use when determining how to price the products my business sells.
The role of pricing in sales is an important one. Price your product too low and you don’t make enough money to stay in business, price your product too high and no one will buy it. The trick is to get it just right, so your customers feel they are getting a good deal and you make enough money to grow your business.
There are three strategies I use to determine an appropriate price for the products and services I sell: value based pricing, cost based pricing and competition based pricing. Each has their merits and drawbacks.
Customer based pricing is also known as value based pricing. This method is only successful when you know how your customers view your products/services. Do they see it as a higher quality item than anything else in the marketplace? Do they see it as the best value? Knowing how your product/service is perceived will give you insight into how to price your item.
I use this method to support the type of image I want my product/service to project. I want the price to say the same thing as my product’s image. Do you want to be seen as high or low end? Look at the organic food market. Organic food items are generally priced a bit above non-organic food items because they are perceived as being a better product. If your item is for a more elite audience, don’t price it too low or your customers won’t see the value of it. On the flip side, make sure you are not over-pricing your items for your bargain hunting customer base.
When making decisions on how to price my products I first ask myself how I want to use this product/service. Will this be a front end or a back end product for my business? Front end products/services are priced lower to bring in as many customers as possible. They can be loss leaders or ones that I just break even with. Back end products are priced at the highest level possible. They are only for my hard-core customers who will give me most of my business. Which one is your new product/service?
A value-based pricing strategy that I frequently employ is the ‘price range’ method. When you are not exactly sure who your customers are, it can be hard to pick a price point. That’s why I like to give customers a choice. I develop three versions of my product/service; a low end, mid-level and high end version with coordination price points. This way I can feel out my customers and get to know their preferences better. In this strategy almost always the mid-level wins out. Make that one your strongest offer.
The drawback to this method is that value alone is not enough to determine an appropriate price. Every business owner worth their salt knows the hard costs associated with making the product and running their business.
If you ignore your costs, you may price your product too low and put your business at risk of going under. This is the basis for a cost-based pricing strategy. In order to properly utilize this strategy you need to know how much your production costs are and your monthly overhead costs. Your production costs are the literal costs you have to produce that item. Things like printing the materials, shipping, assembly, packaging, etc. Overhead costs are things like rent, salary, operating expenses, website hosting, credit card processing fees, etc. The best way to figure out both costs are to make a spreadsheet and list the dollar amount for each cost. The total should give you an idea of the gross revenue you will need to generate each month to run your business.
Once you know your costs you can do a simple mark-up to determine the best price for your product/service. Determine a margin you would like to make off your products to ensure profitability and growth for your business. This tactic is common in businesses that sell lots of items because it is very easy to determine. Business owners who sell clothes or accessories commonly employ this tactic.
Cost-based pricing is also effective in businesses where production costs vary wildly. Businesses that are able to lower their production costs with increased volume of sales don’t have to charge everyone the same amount. They can lower the price, the more items a customer purchases from them. Say you run a bakery. When a customer purchases 30 cupcakes from you, then you can give them a volume based discounted price because your production costs are less.
What if you don’t know your production costs? In some businesses like consulting or custom made products the production costs aren’t readily apparent. In this case business owners can use a ‘cost plus percentage’ based pricing strategy. Usually you negotiate a set mark-up percentage with your customer to tack onto whatever hard costs come up. This is not one of my preferred ways of doing business as the customer can leave feeling they overpaid when they know how much you are making off them.
The negative to the cost based approach to pricing products is that your competitor’s prices are not factored in. The idea of simply marking-up a product/service will only work in industries with little to no competition. Of which there are very few industries like this. Most markets are competitive, and if you don’t look at what your competitors are selling similar products/services for, then you leave the door wide open for them to undercut you with a lower price.
If you want to be successful, you simply must know what your competition is selling and at what price. Competition based pricing strategies relies upon knowledge of the overall industry you are in and any existing competitors.
The basis of this strategy compares your products/services to your competition to determine where you should set your price. Ask yourself if your products/services are superior, equal or inferior to others in the marketplace.
If your product/service is far superior to anything else out there, you may be able to set your price higher than your competitors. The problem with this line of thinking is that nearly every business owner thinks their offer IS superior, when most of the times they are not. For this pricing strategy to work your offer must be heads and tails above the rest, not just mildly better.
Most of the time your product/service will be about equal to what others are offering. You may offer something better here or there, but overall you fair about equal to your competition. In this instance you should price your product the same as all others out there.
You could also price your product/service slightly below your competition to attract customers. This strategy is commonly used when first entering a new market. If you do not have a large customer base, you can use a lower price to draw customers away from your competitors and over to your company. Just be careful you don’t undercut the perceived value of your products and services. Once you’ve done that you’ll have a hard time ever getting your customers to pay a premium for anything you offer.
The most efficient way to determine a fair price for your products or services is to take into account all three factors: value, costs and your competition. The trick is to strike a balance. Product pricing can be daunting without having full knowledge of any of these three areas. So take your time, do your homework and be as flexible as possible.
Good luck!
Ethan Warrick
