It’s common for business owners to set prices based on guesswork or fear, which means many of them leave anywhere from 20 to 30% of their potential revenue on the table.
Rather than undercutting your bottom line to close sales, use this guide to walk you through calculations to protect margins and build sustainable profit.
Pricing models explained: cost-plus, value-based, competitive, and more
Choosing the right pricing strategy is important for a growing business. Picking a model depends entirely on your product, your market, and how your target customers prefer to buy.
- Cost-plus pricing. Also known as “markup” pricing, this straightforward method adds a fixed percentage profit margin directly onto the total unit cost of creating or acquiring your product.
- Flat-rate pricing. A single product with a single set of features is offered for a single price. For instance, a gym membership might offer a flat-rate monthly fee for access to all its facilities.
- Pay-as-you-go pricing. Customers are charged based on their usage of a product or service. This is a good option for businesses with unpredictable customer demand. Examples include prepaid phone plans or cloud storage services where you pay based on the amount of storage used.
- Value-based pricing. Rather than focusing on production costs, this strategy sets rates according to what buyers believe a product is worth. In other words, you set a price based on the benefits and solutions your product delivers.
- Tiered pricing. This model offers multiple packages with different combinations of features at different price points. For instance, software-as-a-service companies often have tiered plans offering different levels of access to specific product features.
- Competitive pricing. This approach uses competitors' historical or current market rates as a baseline to set your own price points strategically. A related strategy is market-share pricing, where you focus on maximizing your business’s market share by intentionally setting a lower price than your competitors.
- Price per user. This is a common model for software companies, where a fixed monthly or annual fee is charged for each person using the product. This allows businesses to easily scale their revenue, and it's more predictable than pay-as-you-go pricing.
- Dynamic pricing. This approach adjusts prices based on real-time market conditions, like consumer demand and competitor pricing. While dynamic pricing is often effective, it can be complex to implement and might not be suitable for all small businesses.
- Subscription and membership models. Under a subscription model or membership model, customers pay a recurring fee to access a product or service, often with ongoing benefits or exclusive content. This is a popular model for things like streaming services, where users pay a monthly fee for unlimited access to a library of content, or certain news websites that offer premium content to subscribers.
[Read more: How to Determine the Right Prices for Your Business]
It’s common for business owners to set prices based on guesswork or fear, which means many of them leave anywhere from 20 to 30% of their potential revenue on the table.
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. For e-commerce brands, transaction processing fees per sale also belong in this category.
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 wages, and divide that by the number of items produced in that time. This ensures your production labor is factored directly into the base build. 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.
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. Because these operational bills stay the same regardless of production volume, they dictate your overall overhead. Figuring out your total fixed expenses in a given time period will tell you how many sales you need to make to break even. Dividing total fixed costs by your per-unit profit reveals your exact break-even point in total units sold.
4. 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. Monitoring key performance indicators alongside customer feedback gives you clear direction on whether adjustments are necessary.
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. Raising prices can sometimes boost perceived quality, while lowering them can unlock higher sales volume.
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.
Popular market research techniques include surveys, focus groups, interviews, and conjoint analysis. Small business owners can leverage easy-to-use online survey tools like SurveyMonkey or Google Forms to collect data.
[Read more: 6 Steps to Performing a Competitive Analysis and How It Can Improve Your Business]
Test and adjust your pricing over time
Pricing is rarely a set-it-and-forget-it decision. Monitoring market shifts and refining your rates over time help build a sustainable business model. 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.
Consider price-testing methods (like A/B testing or localized rollout tests) to understand customer willingness to pay at different price points. This should ideally be done with a large sample size, including those unfamiliar with your brand. 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 to protect margins as your operational costs evolve.
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.
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.
[Read more: How to Calculate Small Business Profit]
Pricing psychology: small tweaks that can increase conversions
Psychological pricing is the practice of setting price points based on consumer behavior and emotional responses rather than cold math alone. Because buyers rarely evaluate costs in a vacuum, subtle shifts in visual presentation can change how fair, premium, or affordable an offer feels, driving higher sales without lowering your rates.
Remove currency signs
Removing dollar signs or currency symbols softens the immediate financial impact of a purchase. Seeing a symbol reminds buyers of the literal pain of spending money, triggering a subtle friction point. Displaying "29" instead of "$29" keeps the customer’s focus entirely on the product’s value rather than its cost.
Use charm pricing ending in odd numbers
Charm pricing leverages left-digit bias, where people process numbers from left to right and anchor on the first digit they read. Ending a price in .99 or .95 makes $19.99 feel significantly closer to $19 than $20. This small shift gives buyers the impression of securing a deal.
Anchor with a high-priced alternative
Anchoring establishes a mental baseline by presenting a high-tier option first. When buyers see a premium package priced at $500, a $150 standard tier suddenly feels like a sensible, high-value bargain by comparison. This visual setup guides customers toward your target middle offer with far less hesitation.
Introduce a decoy option
The decoy effect uses a strategically designed option to make your preferred choice look obviously superior. For instance, offering a digital subscription for $50, a print subscription for $90, and a combined print-and-digital subscription for $100 makes the combined option feel like an unquestionable steal.
Reframe costs into daily breakdowns
Large numbers create immediate purchase resistance, whereas smaller daily costs feel negligible and easy to justify. Reframing an annual $365 fee as "just $1 a day" shifts the buyer's mindset from a heavy commitment to a tiny daily habit that easily fits within their routine budget.
Highlight savings with visual contrast
Visually emphasizing discounts helps shoppers quickly process value without calculating percentage math themselves. Using a larger, bold font or a striking highlight color for the sale price alongside a struck-through original price instantly signals a great deal, triggering an impulse to complete the checkout before the opportunity passes.
Miranda Fraraccio, Emily Heaslip, and Jacqueline Medina also contributed to this article.
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