Comprehensive Yet Concise Guide
The price of a product is among the key factors of its success in the marketplace. At the same time, it is also one of the most difficult aspects of product development to get right. This is because there are many crucial elements, and no one pricing strategy is suitable for all products and all businesses.
The selling price must be carefully considered and tailored to the specific product, market, and business goals. Obviously, you need to start with some theory behind pricing strategies. But ultimately, the best way to price your products is to test different prices in the marketplace and see what works best.
Moreover, you have to determine variable costs, fixed costs, and the desired profit margin, but also understand price elasticity, which is the degree to which market demand for a product changes in relation to price changes.
This guide will provide an overview of the key pricing considerations, as well as some tips and resources for setting a competitive price for your product that will help you achieve your profit margins at the same time.
Why Is Pricing a Product so Important?
Setting the right price for a product is arguably one of the most important decisions a business makes. It is not only an essential element of the marketing mix but also critical to the success of the entire company.
A product pricing strategy should be grounded in financial considerations. The price needs to cover all fixed costs and variable costs, leave a profit margin for the business, and satisfy consumers. What’s more, it must be appropriate for the product and its target market. A pricing model should also take into account competitors’ actions.
In addition, pricing decisions can have a significant impact on how potential customers perceive the product. A higher price can make it seem exclusive or premium, while a low price can make it appear like a bargain. The price point can also influence how consumers perceive the quality of the product. For example, if a product is branded as cheap, customers may assume it is of low quality or has undesirable characteristics (like being inauthentic).
Ultimately, the goal is to find the price point that meets the financial needs of the business while also appealing to consumers and boosting sales volume. Of course, it would be impossible to keep track of all that manually. This is where pricing software comes in.
For example, our Price management tool will keep track of all the market price movements (both wholesale and retail price changes) and help you develop and manage suitable pricing strategies for different groups of products, allowing you to achieve your sales and margin goals.
Product Pricing: Step by Step
Now that you understand the importance of pricing, let’s look at how to price your products.
Research Pricing Strategies
The first step to setting the price for a product is to look at the market. You need to understand how pricing works in your product category and what are the usual entry-level, mid-range, and premium prices. What are the different price points, and how do they relate to the quality of the product?
It’s essential to start with the basics, i.e., the most common pricing strategies, such as:
- Competition-based pricing. To use this pricing strategy, you need to look at how your competitors price their products and try to match, beat, or undercut them in order to attract buyers. Tools like our price and availability tracking tool can help you keep track of trends and strategies used by your competitors and distributors, provide you with a price overview, and deliver frequent reports and analyses.
- Value-based pricing. This strategy focuses on the real and perceived value your product offers to customers in terms of its features, benefits, and performance. Our products’ features information tool may help you find similar competitors’ products and compare them to what you have in order to improve your offering and adjust the prices.
- Cost-based pricing. It’s a product pricing method that considers the cost of production, including fixed and variable costs. In other words, the price you charge for a product should be enough to cover all the expenses associated with it.
- Premium pricing. It refers to setting a high price for a product to create the perception of quality and exclusivity. It may help you achieve the desired profit margin but can also be risky.
- Skimming pricing. It is a pricing strategy that sets a higher price for a product at the beginning of its life cycle to capitalize on the high-profit margins, gradually lowering prices as competition heats up.
- Penetration pricing. Unlike skimming, the penetration pricing process starts with lower prices to attract customers and then gradually raises the selling price as the customer demand increases.
- Bundle pricing. This strategy involves selling a group of products or services together at a discounted price.
- Geographical pricing. It takes into account the different costs associated with shipping a product to different locations.
- Psychological pricing. This product pricing strategy is based on the fact that customers often don’t react in the same way to different prices, even when the difference is small. For example, $4.99 is perceived as cheaper than $5.00, even though it’s only one cent less.
- Cost-plus pricing. Also called markup pricing, this strategy involves adding a fixed or variable percentage to the cost of the product to reach the acceptable profit margin.
The list above is by no means exhaustive, but it covers the most commonly used strategies for new products. Be sure to investigate them further before deciding on a plan for your product.
Your goal is to identify the most common strategies in your niche and determine the pros and cons of each. You may also mix and match different methods to set a price for a specific product.
Assess the Costs and Profit Potential of Your Product
Once you know how pricing products work, it’s time to start looking at your product. What are the variable and fixed costs of developing, manufacturing, and marketing it? How much will it cost to produce each unit? What is your profit margin?
To answer these questions, you need to understand your:
- Bill of materials. This document lists all the materials required to produce one unit of your product.
- Production costs. These costs are incurred in manufacturing your product, including labor, equipment, and facility rental.
- Distribution and shipping costs. These are the fees charged by logistics companies to store and transport your product from the factory to the customer.
- Marketing and advertising expenses. These are the costs associated with promoting and selling your product, including online and offline marketing, sales commissions, and so on.
- Customer support costs. These are the costs of providing post-purchase customer service, such as technical support, warranty service, etc.
- Other overhead costs. These are all the costs associated with running your business, such as office rent, utilities, accounting, etc.
Once you have a good understanding of the total costs associated with your product, you can start calculating profit potential. To do this, you need to know your product’s gross margin, which is the difference between the selling price and the cost of goods sold (COGS).
To calculate gross profit margin, simply subtract COGS from the final selling price. For example, if a product costs $10 to produce and you sell it for $20, your gross profit margin is $10. However, keep in mind that this is just the gross margin, i.e., the revenue, before taking into account all other expenses, such as marketing, shipping, and so on.
To calculate your net margin, you need to subtract all these additional costs from the gross margin. For example, if your gross profit margin is $10 and your total expenses are $5, your net profit margin is $5.
Conduct Market Research
It goes without saying that you can’t price your products without knowing who your target customer is. You need to understand their needs, wants, buying habits, and purchasing power. Only then can you determine how much they are willing to pay for your product.
First, you need hard data on your target market, such as:
- Demographics. This includes age, gender, income, education, and so on.
- Psychographics. This includes lifestyle, personality, values, and so on.
- Buying habits. This includes how often they purchase similar products, what channels they use to buy, and so on.
You can get this data from market research reports, surveys, and customer interviews. Once you have it, you need to segment your target marketinto different groups based on their needs, wants, and purchasing power.
For example, if you’re selling a new type of toothpaste, you might segment the market into three groups: budget-conscious consumers, health-conscious consumers, and premium consumers. Each group would be willing to pay a different price for your product.
It might be helpful to create a buyer’s persona for each segment, which is a detailed profile of your ideal customer. It will allow you to better understand their needs, wants, and motivations.
Understand Price Elasticity in Your Target Market
Once you know your costs and profit potential, it’s time to start thinking about the right price for your product. But before you can do that, you need to understand how customers in your target market will react to price changes.
In other words, you must know the price elasticity of demand for your product. Price elasticity is the degree to which demand for a good or service changes in relation to price changes. It is usually expressed as a positive or negative number.
There are four main types of price elasticity:
- Perfectly inelastic. This is when demand for a product does not change in relation to price changes. An example of a perfectly inelastic good is water; people will continue to buy it even if the price goes up.
- Perfectly elastic. This refers to a situation where demand for a product changes dramatically with price changes. A perfectly elastic good would be, for example, movie tickets; people may not buy them if the price is too high.
- Unit elastic. This happens when a change in one variable leads to an equally proportional change in the other variable. For example, gasoline may be a unit elastic good; if the price increases, people will still pay for it but may drive less.
- Relatively elastic. This is when demand for a good is greater than a price change. It is often the case with luxury goods, e.g., a slight decrease in the price of a phone may lead to a significant increase in demand.
- Relatively inelastic. It is the opposite of relatively elastic and means that the percentage change in demand will be smaller than the percentage change in price. An example of a relatively inelastic good would be bread; people are not likely to buy more of it just because the price has gone down.
To calculate the elasticity of demand, you need to know the percentage change in quantity demanded (Qd) and the percentage change in price (P). The formula is as follows:
Elasticity = % change in Qd / % change in P
For example, if the price of a product increases by 10% and the quantity demanded decreases by 5%, the elasticity would be -0.5.
It’s important to note that the elasticity of demand can change over time. For example, a new product may be inelastic in the early stages of its life cycle but become more elastic as the competition enters the market.
Test and Experiment with Prices
The theory is vital, and data is essential, but at the end of the day, the only way to know for sure what final price will work best for your product is to test it in the marketplace.
You can do this in a couple of ways:
This is a method of experimentation where you compare two product variants to see which one performs better. For example, you can create two versions of your product listing on an e-commerce site with different prices and see which one generates more sales.
You can also use A/B testing to compare various pricing strategies, such as value-based pricing vs. cost-based pricing models. The key is to change only one variable at a time so that you can isolate its effect on the results.
The advantage of A/B testing is that it is relatively quick and easy to do and doesn’t require a large sample size. You need to be careful, though, not to make too many changes at once, as it will be difficult to determine which of them had the biggest impact. Moreover, if your customers discover that you are testing different prices, they may become frustrated and lose trust in your brand.
Another way to test prices for your product is to survey your target customers and simply ask them how much they would be willing to pay for it.
You can do this online, using a tool like SurveyMonkey, or offline by conducting in-person interviews or focus groups. The key is to find a representative sample of your target market and ask them the right questions.
To get started, you can use a free pricing survey template. It will provide you with feedback from customers in an easy-to-digest format. However, its straightforwardness may turn out to be the survey’s downfall, as it is not very flexible and may not allow you to collect all the data you need. What’s more, it’s not always reliable, as people’s responses may be influenced by their current mood or the way the questions are worded.
This is a more sophisticated method of surveying customers that allows you to understand how they value different product attributes.
It works by presenting respondents with different hypothetical product scenarios and asking them to choose the one they prefer. For example, you might show them two products with different prices and feature sets and ask them which one they would buy.
The advantage of conjoint analysis is that it allows you to understand not only what price customers are willing to pay for your product but also what features they value the most, which can be the key combination for achieving your profit margin goals. However, it is a more complex and time-consuming method than simple surveys.
Monadic testing is also a form of surveying customers, but it offers a little more insight, allowing you to create a curve that shows how the demand for your product changes in relation to price changes.
This price testing method uses a split cell test design, where you describe a product to your respondent, already naming a proposed price and asking how likely they are to buy it. Respondents should be able to choose their answer on a scale from “Very Unlikely” to “Very Likely.”
Then, you can repeat the exercise with a different price and see how it affects the results. After that, you may plot their responses on a graph to see how demand changes as the price changes. This will give you a good idea of the optimal price for your product.
This method of price testing is very similar to monadic testing; it has the same goal, but the form is slightly different.
When conducting price laddering testing, you present your respondents with a product description and a proposed price, asking if they would buy it. Then, you repeat the process with a different price point, going up or down the “price ladder.” Usually, you’d go down, starting with the highest price and lowering it until a respondent says they would buy the product.
Once you have sufficient data, you calculate the average or most commonly chosen price point and use it as the starting point for your product’s price.
Product pricing is a complex task that requires careful consideration of many factors. The most important thing to remember is that there is no one-size-fits-all solution; the price you set must be appropriate for your product, target market, and business goals.
The best way to find the final price for your product is to test different prices in the marketplace and see what works best. Be sure to start with some basic research on pricing strategies, understand your product’s costs and profit potential, and determine the desired profit margin.
Then, segment your target market and determine their willingness to pay for your product. Only then can you start experimenting with prices.
Manager with experience in leading team of software developers and testers during implementation of internal and external IT projects.