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How to set the right price for your product

Last updated

6 May 2023

Reviewed by

Cathy Heath

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Pricing a product or service is one of the more complex decisions businesses must make. To maximize profits, the process involves considering various internal and external factors, including competition and market data, developmental costs, and customer demand. 

Consequently, when choosing a pricing model, your decision can impact almost every part of your organization. That's why understanding how to set the right price for your product is critical to the overall success of your business. 

What is product pricing?

Product pricing is determining a selling price for a service or product based on internal and external factors. Product pricing aims to match the product or service's value with its cost and customer demand so that an organization can maximize its profits while still offering competitive prices. 

Product pricing tends to directly impact a business’s overall success, from customer demand to profit margins and cash flow. These pricing strategies also tend to differ based on target customers, the industry involved, and the cost of goods. 

For example, competitive pricing strategies are often preferred when there are a lot of similar products or services in the market, as you can capture market share by offering a good deal. However, in e-commerce, subscription-based pricing models are more frequently used.

How should I price my products?

Pricing a product isn’t something a company does only once. In truth, because the process is complex and price factors are constantly changing, you need to perform thorough market research to understand better who your ideal customer is before you decide on any prices. This information can assist you as you look into pricing strategies that may work for you and your goals. 

Four common product pricing methods

Although there are countless product pricing methods to choose from, there are some pricing strategies that are more common than others. These strategies include the following: 

Value-based pricing

Value-based pricing is a strategy that sets prices based on consumers' perceived value of a service or product. This means that instead of your company looking internally or at competitors to set prices, this method tends to use an outward customer-focused look and base pricing on how much customers believe something should be priced. 

This method is usually used by companies that offer unique or highly valuable goods or services or have the time and the resources to execute the product or service offering well. 

Competitor-based pricing

Competitor-based pricing is a pricing strategy where entities look at their competitors' pricing structures and then use this information to create their strategy. This method also involves looking at market trends and setting a product's price accordingly. 

Yet, while any company can use this method, it tends to work better for organizations with similar services or products to their competitors. 

Cost-plus pricing

Cost-plus pricing, also known as markup pricing, bases product pricing on the cost of production and desired profit margins. Once the company considers these two factors, it applies a markup percentage to these costs to reach an asking price. For instance, retail brands aim for a 30–50% profit margin. 

Dynamic pricing

Dynamic pricing, also known as demand pricing, surge pricing, or time-based pricing, is a strategy companies use to adjust their prices based on the changing demand. Typically, this pricing strategy takes place based on the following:

  • Groups: Organizations will offer product prices to different groups based on location, demographics, and other characteristics. 

  • Time: Prices will change depending on time. For instance, in car lots, prices will go down at month's end because salespeople want to meet their quotas. Or airlines will shift seat prices depending on the time until the flight. 

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Important metrics that should inform your product pricing

To find success, one of the critical things that organizations need to do is monitor metrics, especially if they want to determine their product pricing. While countless metrics can help companies get ahead, some of the more essential ones that can usually help businesses grow include the following: 

Fixed costs

Fixed costs are a term that refers to costs that cannot be changed regardless of a business's performance. These fixed costs are independent of a company's sales or production level. Instead, these expenses, also known as indirect costs or overhead costs, are necessary expenses that keep a company afloat. 

Fixed costs will usually stay the same whether a company is doing well or going through rough times. As a result, even if sales or production fluctuates, the fixed costs will remain stable. 

Variable costs

Variable costs are those expenses that relate to the production and delivery of products and services sold by a business. These costs depend on the amount of product a company sells or produces, which means that the more a company sells, the higher its variable costs will be, and if a company scales back its production, then variable costs will drop. 

Consequently, companies want to aim for low variable costs that can enable them to have larger margins so that they can be more profitable. 

Consumer surplus

A consumer surplus occurs when the price of a product or service that consumers pay for is less than the price they’re willing to pay. This metric measures the additional benefit customers receive because they’re paying less for something than they were willing to pay. 

Consumer surplus tends to increase as the price of goods falls but decreases as the price of a good increases. 

Market demand

Market demand refers to the need for a specific product or service and who wants to purchase it. The metric is determined by:

  • The number of consumers seeking the product or service

  • How willing consumers are to spend a certain price on a specific good or service

  • How much of the product is available to consumers

As a result, when market demand increases, so does the price. However, when the market demand decreases, the price will also decrease. 

Market demands tend to fluctuate over time, and the cause can be due to many factors. For instance, these price changes can result from seasonal factors, predictable factors, natural disasters, and even pandemics. 

Cost of goods sold (COGS)

The costs of goods sold, or COGS, refers to the total cost of inventory that a company has sold. This figure is determined by adding together the costs of labor and materials as well as overhead costs associated with each unit of inventory sold. 

Some of the more common examples of the cost of goods sold include things such as:

  • Shipping costs

  • Manufacturing parts

  • Labor associated with the building or assembling of products

What are two examples of product line pricing

Product line pricing involves separating goods and services into cost categories to create several perceived quality levels in the customer's mind. Product line pricing aims to maximize profits by putting new goods with the highest number of attributes at the highest price point. 

However, you’ll also be keeping base products, or those older goods with lower performance expectations, on sale at a lower price so that you can provide goods to meet everyone's needs.

While this strategy is one of the most popular, especially for those companies looking to have their products bolster broad appeal, it can also allow organizations to market to different customer types and anchor their goods.

Two good examples of product line pricing include:

ASOS Shoes 

ASOS offers product lines that provide goods for all types of customers. For instance, their boot line includes a variety of boots (leather, faux leather, and canvas boots), all from the same collection. However, each pair of boots is set at a different price point to differentiate the quality of the boots. 

Hotels

Many hotels offer budget rooms as a base product. These hotel rooms are for the hotel's product line, which means that they cater to all types of customers and can meet each of their needs. However, if you want a room with a view or concierge services, you’ll likely be charged extra for the features.

Step-by-step guide on how to price a product

Generally, if you’re looking to figure out how to price a product, the following steps are a great place to start:

Calculate your variable costs per product

The first thing to do when determining how to price a product is to figure out how much it will cost to make a good or provide a service. This is because if you want to turn a profit, you must ensure your expenditures are covered. Typically, this includes labor, materials, and overheads. 

Add a profit margin

Next, you’ll want to calculate your desired profit or the percentage of revenue that will be profitable once you deduct all of your expenses. This figure is known as the profit margin. 

This profit figure can be arbitrary, or you can look at other organizations in your industry for further guidance to calculate a number. You can even compare your desired profit margin to others in the industry.

Assess the market

The more you know about your target audience, the better chance you have of coming up with a price that helps you make a profit. Some topics to assess when you’re looking at the market include things like:

  • Demographics, including age, general income level, and location

  • Budgets and how important the price is to customers when it comes to purchasing something

  • The motivation behind buying certain items

  • The status of a brand name and whether it drives customers to buy a product 

Reviewing these questions can help determine whether your target market's primary focus is on comfort, cost, luxury, or feature set. For instance, if their preference is cost, pricing tiers may incentivize your target audience to buy your services and goods. However, if their main concern is their comfort, you may be able to ask for more money by promoting the features of a product and showing your customers how unique it is from the competition. 

Look into your competition

Although you don’t want to use the exact same techniques that your competition does when it comes to pricing a product, reviewing the rationale behind their pricing can help you develop your own guide. 

For starters, you can compare similar products and note their price. Or you can look at social media to figure out what type of demographics your competitor is trying to target and the marketing strategies they’re using, such as the type of promotions they offer. This intel will give you more insight into whether you should match their prices regarding similar goods or provide better options for your customers. 

Set a price and monitor it

Finally, you’ll want to review the popular pricing strategies and decide which one you want to use to set your prices. But remember, just because you set a price, it doesn’t mean it won’t change. You’ll want to regularly monitor your expenses and determine how successful your product or service is in the market. 

In addition, keep an eye on the competition's prices as the market changes, and determine if you need to make changes to your pricing structure when they do. If you need to make changes, adjust prices as necessary. 

Finally, track your costs, which can help ensure you continue to profit from the goods and services you offer.

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