How to Price Your Products

pricing-strategy

Pricing your products is tough for all businesses, but especially so for ecommerce business owners. Pricing your products incorrectly can make or break your business. If you do it right, you'll see your revenue climb. You do it incorrectly and you can scare off even the most interested buyers.

There are several pricing strategies out there, and choosing the best one is not always easy.  Today we're going to go over three basic pricing models.

While price is not the only factor customers consider when buying products and services, it is often used to compare similar products.   According to Hubspot, 80% of customers say that the most important factor influencing their purchasing decisions is competitive pricing. In addition, more than half of customers name pricing as a major influence when they are making their purchase decisions.

Most business owners base their pricing decision on how it affects the bottom line.  If your priciing strategy is to ensure maximum profitability, you may be pricing yourself out of the market.  Not pricing your products or services competitively can cause you to lose customers.

Cost-Based Pricing
Cost-based pricing is one of the most popular pricing strategies used across the world.It uses the products initial cost to determine the retail price, by marking the product up by either a percentage or flat amount above the original price of the provider.   

Cost-based pricing can be classified into three categories:

  • Markup pricing: Markup refers to the difference between the selling price of a good or service and its cost. It is presented as a percentage above cost.

The following formula is used to determine the markup amount: (Selling Price) — (Original Cost)

For example, if the original cost is set at $10 per piece, and you sell your product for $15, your markup price is $5: ($15 Selling Price) — ($10 Original Cost).

Therefore, the markup on the product will be 50 percent: ($5 Markup Amount) / ($10 Original Cost) x 100.

Markup pricing is useful when dealing deal with cost fluctuations. Since it is created as a percentage, you're guaranteed to generate a proportional amount of revenue on each sale you make.

  • Margin pricing: Margin pricing is similar to markup pricing as they both refer to the amount that is added to the cost of a product to calculate a retail price.

However, with margin pricing, you take into account the cost of the particular product and all other costs that must be covered, as well as the volume of business and your profit margin.

To find out your maximum margin, you first need to figure out your gross margin: (Selling Price) — (Cost of Goods Sold)

The gross margin is then divided by the price and multiplied by 100: (Gross Margin) / (Selling Price) x 100

Using the example from above, your gross margin would be $5: ($15 Selling Price) — ($10 Cost of Goods Sold).

Your margin percentage would then be 33.33%: ($5 Gross Margin) / ($15 Selling Price) x 100.

  • Planned profit: Planned-profit pricing is a bit more complicated and requires businesses to determine the total profit they expect to earn from the sale of a particular product, and then adjust the price of each individual piece accordingly.


The formula for planned-profit pricing is: (Cost) + (Desired Profit Margin Per Unit)

For instance, if a shoe company intends to earn $50 per pair of shoes sold, and each pair of shoes costs the company $15 to purchase (or have made), the planned profit price would be $65 ($15 + $50).

When deciding which cost-based pricing method to use in your business, it is important to weigh the pros and cons.

Pros:
  • Allows you to easily determine the price.
  • Ensures profit from each sale.
  • Enables you to justify price increases, since you factor in all your costs.

Cons:
  • Does not consider the competition.
  • May lead to overpricing or underpricing.
  • May not always consider actual consumer demands.

Value-Based Pricing
Value-based pricing establishes prices for your products based on their perceived value by the customer. Once you have defined the value your customers get from your product, your goal is to find out how much money they are willing to pay for it.

From a value-based perspective it is recommended that you define and engage your target market first. This includes digging deeper into your clients' psychology and behavior patterns, such as:

  • Their goals of using a particular product.
  • The advantages and disadvantages of using the product.
  • Why customers need and want to spend money on the product.

After analyzing your target customer, you need to figure out how your products or services will meet their expectations. When implementing value-based pricing, you must also consider any value added.  For example, if you provide excellent customer service, money-back guarantees, and other services that go above and beyond what your competition provides, you should certainly factor that into the end price of your product.

You have to be certain that your target customers consider this additional service to be valuable. Incorporating these value-added elements into your marketing strategy is critical. Whether it's by printing it on your packaging or highlighting them on your social media channels, be sure they are clearly visible. If not, customers may not be willing to pay for it. This model like all others, also comes with its pros and cons.

Pros:

  • Value-based pricing allows you to meet your customers' expectations.
  • The price you set is normally the price your customers are willing to pay.
  • This allows you to justify your pricing of the value-added services.
  • Customers are likely to be much more receptive to increases in your prices over time.
  • Ultimately, this allows you to be lean in terms of product and service development.

Cons:
  • Resource-intensive pricing framework that requires more research and needs to be ongoing.
  • Trends fluctuate and you need to stay on top of this at all times.
  • "Value" is subjective to each of your individual customers.

Dynamic Pricing
Dynamic pricing is also known as "market pricing" or "competitive pricing". This method uses industry data to competitively establish prices.  In order to set dynamic pricing, it is necessary that you invest in dedicated software that allows you to:

  • Easily collect and analyze data from the industry.
  • Calculate the profitability of various price ranges for various items.
  • Segment pricing data that allows you to analyze your target audience.


Regardless of the industry you work in, you want to know the average price and the most common mid-range price of each product you need to price. The data you gather can then help you to price your product slightly lower than what is offered by most competitors for the same product.

Of course, you still want to consider your desired profit margin as well as the total revenue you want to generate by selling your product or service.  Outselling your competition with a heavy price cut may lead to increased sales volume, but if your profit margin is too low, your sales revenue will suffer.

Keep in mind your store's reputation as well. The better your brand reputation is, the more flexible you can be with your end price.  

Once you have determined the price point for your products, be sure to closely monitor your conversion rates and revenues, as well as market fluctuations.  

As in all pricing models, it is important to consider both the pros and cons.

Pros:

  • Allows you to find the "sweet spot" for pricing your products.
  • You won't be uselessly undercutting the competition.
  • You won't be losing sales by setting your prices higher than the market average.


Cons:

  • Implementing dynamic pricing can be time-consuming and labor-intensive.
  • This may also be costly, as you'll almost certainly need to invest in a software solution.
  • Dynamic pricing is not a "set and forget" model.
  • Can sometimes lead to price wars, as competitors may hit back by under-pricing you again.


Wrap Up
Proper pricing of your products has a direct impact on the success of your ecommerce business. So, it's recommended that you consider each pricing method carefully before making a final decision on pricing. 

Final Tips:

  • Never try to forcefully implement a pricing strategy if it doesn't actually make sense for your online store.
  • Always consider your overall business model, trends in your industry, and your customer profile as you make your pricing decisions.


Keep in mind that whichever pricing method you choose today, you are not obligated to keep that pricing method for ever.  It's okay to change your mind later: though often a change in pricing strategy calls for a re-branding or other big shift in the way your business operates.

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Tuesday, 28 September 2021
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