Product pricing is a complex decision, one that can make or break your business. Pricing considerations are unique to every small business, but the price you set for your products typically impacts your sales numbers and revenue.
Production costs, product demand, competition, and brand awareness all influence pricing strategies. These 6 steps will help you start pricing your product.
assess the cost
The first step in determining how to price a product is to establish the costs of producing the product or providing the service. After all, to be profitable, you have to cover all your expenses. In general, expenses fall into three categories: material costs, labor costs, and overhead costs.
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material: Materials constitute the raw materials of production. For example, when making clothes, materials may include cloth, buttons, and threads. If you offer services such as a cleaning company, you’ll need mops, buckets, and other cleaning supplies. If you source the product from another business, the materials are the item you got from the original seller and what you need for repackaging.
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Labor: Labor measures all the physical and mental labor required to create a product. Whether it’s a factory worker or an office receptionist, when you hire someone who adds value to your business, that person becomes part of your labor accounting. This includes salaries and wages paid to employees, related payroll taxes and employee benefits.
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overhead: Overhead costs are costs that do not fall into the material and labor cost categories. This includes rent, utilities, business license, marketing Advertising, insurance, office supplies, attorney fees.
Adding these numbers together gives the total cost of the product or service output. Be sure to consider whether each expense is a fixed monthly amount, such as rent or insurance, or variable, such as marketing expenses or certain utility bills. To calculate variable costs for pricing purposes, use the average monthly amount based on the annual total estimate.
determine desired profit
You can calculate your desired profit as the amount above the cost of the output you want to produce per unit or per customer. Another option is to calculate the percentage of actual earnings after deducting all expenses. Profit rate.
You can seek guidance from industry professional associations, but profit targets may be somewhat arbitrary. If you want to compare your desired profit margins to those of your industry peers, Risk Management Associates is a non-profit organization that produces reports on the financial health of small businesses.
understand the customer
Focusing on your target audience and understanding their motivations plays a big role in pricing your product. budgetmay work with a third-party research firm, or collect data yourself through surveys, face-to-face conversations, or other means.
Here are the topics and questions we cover in our target audience research:
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Demographics: What is their gender, age, approximate location and income level?
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Competitive Intelligence: What are their favorite products or services that are similar to yours? List some options to choose from.
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Budget awareness: How important is the product price when purchasing a product?
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motivation: Do you prefer price or convenience when making a purchase?
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Status: How important is the product brand name?
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Psychological sensitivity: Are they more likely to buy the $9.89 product than the $10 product?
The answers to these questions will help you determine whether your target audience’s primary interest is cost, comfort, feature set, or luxury. If the priority is cost, product or service bundling or tiered pricing may appeal to their tastes. If comfort is your primary concern, you might decide to charge more and emphasize the features that differentiate your product from its competitors. For associated customers, we recommend that you consider increasing your prices to match customer expectations.
research competitors
Even if you don’t want to mirror your competitors’ pricing perfectly, researching their strategies can help you develop your own strategy. Start by searching online for companies offering similar products and checking their prices.
Such as Google Alerts, a free digital marketing tool that emails alerts on product, industry and competitive news on topics and brand names of your choice, and Google Trends, which can provide information on popular search terms such as: online tools are available. Competitor name.
You can also follow your competitors’ social media accounts to learn about their target audience and marketing strategies, such as what promotions they offer and when. This gives you an opportunity to consider whether you can match or exceed your discounted pricing strategy.
Choose a pricing strategy
With the information you’ve gathered so far, you’ll be ready to evaluate common pricing strategies and decide which one to use for your own pricing. It’s just a framework for guiding the decision process. You can incorporate several methodologies to calculate the selling price of your products and adapt these tactics to your unique business needs.
cost plus price
what is that: Based on the sum of overhead costs and desired profit.
When to use: Ease of communication and justification helps build trust.
Disadvantage: Ignore brand image and competition.
Cost-plus pricing is a textbook model of how products are priced by calculating the cost of production and adding a desired level of profit to determine the product price. However, factors such as customer preferences, brand image, and competition are not taken into account, and the laws of supply and demand are largely ignored. When using this approach, be sure to consider hidden costs such as inventory markdowns and seasonal staff increases.
Market share pricing
what is that: Lower the price and increase the number of customers.
When to use: when there are many competitors.
Disadvantage: May attract unloyal bargain hunters.
Market share pricing emphasizes quantity over price with the goal of maximizing market share (the percentage of the industry your business controls). The main goal should be customer acquisition, which should ultimately lead to a net increase in revenue. This model allows you to offer your product at a lower price initially, but as more people use it and your market share grows, your product becomes more valuable and you can raise your price. The ability to develop brand loyalty is important here, as consumers who once switched companies because of price may switch companies again if your product is no longer the cheapest.
dynamic pricing
what is that: Prices vary according to region and needs.
When to use: This can be useful when offering products that are in high demand.
Disadvantage: It can alienate customers who missed deals.
Dynamic pricing is also known as demand pricing, surge pricing, and time-based pricing. This is a strategy in which the price of a product fluctuates according to demand. It takes into account when and where the product is offered or sold and how demand for it is increasing. For example, airlines use dynamic pricing. Ticket prices may vary depending on seat type, seat availability, flight duration, destination and other factors.
competitive price
what is that: Adjust prices strategically based on competition.
When to use: For businesses that might otherwise not stand out against their competitors.
Disadvantage: Continuously monitoring competition can be time consuming.
Competitive pricing models are common in saturated markets, such as grocery stores and gas stations, where it is difficult to distinguish between the businesses that sell your products. Often there is a market leader who sets the standard and competitors follow suit. When one firm raises or lowers its prices, others feel compelled to follow suit. If you charge more than your competitors, you must convince consumers that you are offering a superior product or service.
value added price
what is that: It’s based on how much your customers believe in the value of your product.
When to use: For a business that beats the competition.
Disadvantage: A truly new product has no effect.
The value-added pricing model targets buyers who are more likely to accept a higher price when they perceive the product to add value. The value our products and services provide includes convenience, status, first-of-its-kind technology, advanced features, uniqueness, and unparalleled customer service.
Monitor prices and adjust accordingly
Regardless of which pricing strategy you use, you rarely set a price just once. You can expect to monitor prices regularly and adjust as needed. Be aware of competitor pricing and market changes.
Plus, keep track of labor, material, and overhead costs to keep your sales profitable. If the cost of producing these increases, we will need to adjust our prices accordingly.
Freelance writer Elizabeth Kellogg contributed to this article.
A version of this article originally appeared on Fundera, a subsidiary of NerdWallet.