A basic guide to product pricing

Posted in Financial management.

When deciding how to price your products there are many things to take into consideration. Not only should your pricing cover all of your costs but also be profit-generating. There are risks involved with incorrectly pricing your products. Underpricing may lead to you not being able to cover all of your costs whilst making your products appear cheap and of a lesser value. On the other hand, overpricing can make your customers defect to your competitors or cause you to be outpriced in your target market.

To avoid the above pitfalls, take a look at this basic guide to price products correctly:

Making a profit

It is always vital to set goals and then establish how to achieve these goals. Therefore, when it comes to pricing you need to know how much profit you need to make.

If pricing for a single product you can estimate the number of units you plan to sell over the next year. Take your profit target and divide it by this unit amount and you will have the price. When pricing numerous products, allocate your total profit goal by each product and do the same as above.

Getting to know your customers and target market

Use research to determine who your customers are and what they need. This can be done in-house (via the Internet, public databases and surveys) or by a third-party market research team, which can be expensive but more in-depth and well worth the money.

Find out what your target market’s demographics, psychographics and purchasing behaviors are. Are they looking for the cheapest price or do they prefer value over a low price? Do they prefer mass production over quality or vice versa? Are you selling low-end or high-end products? Do your customers splurge more on certain types of products?

If you want to learn more about ways to research your target market, read our in-depth article here.

Sizing up the competition

As with customers, research is also important when considering your pricing and how it compares to your competitors. What are they charging for similar products? This can be done by searching their websites or review sites. Do your competitors’ products have more or equal value to yours? Comparing competitors’ prices can help you to establish a profitable price that also reflects good value for money.

Selecting a pricing technique

Choosing the right pricing technique can help maximize profitability for each unit sold. There are many types of pricing strategies that one can apply including competition-based, customer-based, marginal-cost, time-based, high-low and psychological pricing. We will be going into more depth on these in an upcoming article. For now we give an overview of the two most common types, namely cost- and value-based pricing.

Cost-based pricing takes into account the costs involved in the production and distribution of a product. One calculates the costs and adds a markup percentage to create a profit margin. This pricing emphasizes the features of the product. Cost-based pricing makes it easier to lower prices through lowering the overall costs. This is helpful in trying to beat competitors. However, small companies do not do well with this kind of pricing as they might need to sacrifice quality in order to compete with bigger companies.

Value-based pricing looks at the estimated or perceived value to the customer, as well as the value on the market. Historical prices and cost of product is not included here. Unlike cost-based pricing, value-based pricing focuses on the benefits a product can provide. It requires a deeper analysis of the customer and their needs which is great for understanding what your market requires and then being able to provide for that. On the other hand, this type of pricing can potentially alienate customers who prefer affordability.

Calculating costs

This is essential when using a cost-based pricing method. You need to know how much it costs to produce a product to know how much you can sell it for in order to make a profit. The top three costs you need to look at include the cost of goods sold, fixed costs and variable costs.

The cost of goods sold involves asking how much money is being spent on developing the product. Remember to include marketing and sales costs here.

Fixed costs are the non-labor costs needed to keep the business open. These tend not to fluctuate. No matter how many products you sell, you still have to pay these costs. These costs can include rent, salaries, fixed assets depreciation, legal and accounting costs.

Variable costs differ from month-to-month and can even depend on how much sales are done during a certain time period. These costs can include printing, packaging materials, shipping, stocking, office supplies, and utilities.

Regularly review current pricing

Don’t stagnate when it comes to pricing. Schedule a review of your prices on a regular basis to account for market demand, response to competition, change in profit objectives and so forth.

The following circumstances may call for a pricing review:

*  Increase or decrease in overall company costs
*  Changes in competitor pricing
*  Economic inflation or recession
*  Introduction of a new product or product line
*  Changes in sales strategy
*  Entering a new market

Remember that although the correct pricing of products is important, having the best salesperson and sales strategy is just as significant to help increase sales. Therefore, focus on both pricing and sales for success.