Pricing a product requires careful planning and an understanding of the value of the work you put into making it. You’ll want to ensure you’re earning enough revenue to cover the costs of keeping your product — and business — in the market while remaining competitive with other players in your industry.
Here are some best practices and steps you can take to figure out the best price for your product.
Which pricing model should you use?
There are a few different factors to consider before you calculate your product price. First, determine the pricing model that will help you find the balance of value and revenue. From there, you can create a pricing strategy that will help your business grow. Likewise, you can experiment with pricing tactics that will help you fine-tune your price per item.
The most common pricing models are:
- Flat-rate pricing.
- Pay-as-you-go pricing.
- Tiered pricing.
- Price per user.
- Subscription/membership pricing.
Flat-rate pricing is the most common model for retailers and other merchants that sell a discrete product since it requires simply calculating one price per item. You could also offer more than one pricing model, like a monthly subscription box of product samples in addition to regularly sized products. Flat-rate pricing is relatively straightforward. Just follow these simple steps.
How to calculate product pricing, step by step
1. Add up variable costs per product.
Variable costs are directly tied to the product. These costs increase or decrease depending on how many products you make. Raw materials and shipping supplies are both examples of variable costs.
It’s easy to determine a product’s variable baseline cost if you purchase inventory. But, if you make it yourself, your product’s cost is the price of bulk materials divided by the number of items produced.
Next, look at hourly or daily wage, and divide that by the number of items produced in that time. Finally, consider packaging and bonuses. Use unit pricing to calculate the cost of shipping supplies and branded “freebies” (like decals or printed coupons), and add fees determined by your delivery service.
[Read more: How Should I Price My Product or Service?]
2. Add in your profit margin.
A profit margin is the percent of a sale that is profit. For example, if a product with total variable costs of $10 sells for $12.50, its profit margin is 20% (the $2.50 profit is 20% of the sale).
If your goal is a 20% profit margin, you can work backward to determine your pricing using this formula:
Price = (total variable costs) / (1 - 0.20)
If the calculated price is much higher than your average competitors’ pricing, you may need to reconsider your production costs. If your price is low, you may be able to plan for an even higher profit margin.
3. Factor in fixed costs
Fixed costs relate to the functioning of your business and include items like insurance, rent, software licenses and permits, and payroll expenses. Figuring out your total fixed expenses in a given time period will tell you how many sales you need to make to break even.
4. Test and adjust accordingly
You will need to give your product time in the market to understand how customers respond to its pricing. Usually, conducting a quarterly review can help you gauge customer interest and satisfaction.
If you find sales are lower than needed after a quarter with your product or service set at a particular price, use your industry knowledge to determine if that means pricing up, down, or cutting your own costs.
[Read more: How to Price Your Business Services]
You will need to give your product time in the market to understand how customers respond to its pricing. Usually, conducting a quarterly review can help you gauge customer interest and satisfaction.
Best practices for pricing your products
Before you set your final price for a product, it helps to do some research and follow some strategic best practices.
Understand common pricing strategies in your industry
Pricing your product requires background knowledge of your industry. Compare your product to similar ones in the market to determine an average price range. If your product is of higher quality, customers may be willing to pay slightly more. If your product lacks all the bells and whistles, you may be able to compete on price with larger competitors.
Conduct market research
Your customer base is your best guide for what works and what needs to be changed. Market research, whether conducted internally or outsourced to a market research firm, will give you important insights into what your customers want and what your competitors are offering (or lacking). This information will also serve as a foundation for your pricing strategy.
[Read more: How to Conduct Market Research to Better Understand Your Customers]
Experiment with pricing
If you’re just starting your business and testing out a minimum viable product, you may have some room to experiment with pricing. To gather the data you need, you will need a large sample size of customers, including customers who are not your usual, repeat buyers. With incremental changes in price within set time windows, you can get real information about what people are willing to pay.
Be open to ongoing experimentation with your pricing. You may need to make adjustments to your goals and work new practices into your production and marketing strategy.
Focus on long-term business profit
Customer lifetime value (CLV) is a measure of the total amount of money a customer is expected to spend on your products during the entirety of an average business relationship. This metric can help you understand customer loyalty. Since loyalty and retention go hand in hand, this metric can clue you into whether customers are coming to you for a deal, or really love your product.
If you find yourself constantly discounting your products to keep generating sales, take a hard look at your CLV. You may be targeting the wrong customer group, and should adjust your pricing for a different segment.
“If you understand your CLV well, that can help shape your business strategy to keep loyal customers, rather than investing the resources in acquiring new ones. Of course, new and current customers play an important role in business building in general,” wrote Shopify.
As your business evolves, keep your customers with you by rewarding their loyalty and offering incentives to keep buying from you. Increasing your CLV, while keeping your product or service relevant to a wider market, will help keep your company growing for years to come.
This story was updated by Emily Heaslip.
[Read more: How to Create a Customer Loyalty Program for Your Business]
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