Pricing merchandise is a crucial aspect of running a business. A lot goes into finding a sweet spot for each of your products. This is true whether you’re a brand new business entering the market or an established company offering a new line.
The importance of pricing cannot be overstated, as it has a direct impact on your business’s sales, profit margin, and beyond. It can also have a strong influence on customers’ perception of your product. Figuring out the right price has as much to do with trial and error and human psychology as it does with mathematical computations.
Depending on the type of product, the type of business, and the type of market, different strategies will work better for different businesses. There really is no one size fits all formula when coming up with a proper pricing strategy.
Nevertheless, there are several tried and tested methods that are generally used in deciding how to determine the price of a product. Below are some of the things to consider when you work on pricing items:
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How Much Does a Product Really Cost to Make
It’s impossible to determine what the best price is for a product before knowing what the product costs you to make. Oftentimes you will hear people complain with a statement like “how much does this piece of plastic really cost?” This type of statement ignores the true cost behind what goes into bringing a consumer good to market.
For example, if you are selling a toy imported from China, the true cost behind that product isn’t just “a piece of plastic.” It involves a long list of expenses, including freight, shelf space, rent, electricity, advertising, salaries, insurance, etc. Don’t forget the cost of borrowing and what you will owe back to investors.
When you calculate your margins to properly price your items, it’s crucial to take into account all of these factors. Don’t forget to include not only the current true cost of the product, but also what predicted expenses you will have in the near future as your business expands and grows.
Put together a committee and/or workshop from different departments to bring their own skills and concerns to the table. So many elements go into calculating the cost of a product. As such, every team’s voice should be accounted for.
By including the finance, marketing, and sales departments in the formulation of pricing, your company will achieve a more viable and thought out plan for turning a profit. For small businesses this may look like simply getting feedback and input from all of your employee roles. Trust your staff to give you honest feedback and allow for some flexibility in your pricing.
It really helps to know what people are paying for similar products and services in the marketplace. For small businesses, this can be simply asking for customer feedback in-person or through soliciting surveys in emails. Other bigger companies will hire consultancy firms or individual analysts to perform this research. These studies are based on any number of sets of information from conducting interviews and focus groups to analyzing consumer data for specific counties.
Thinking about who your potential customer is, what they’re willing to spend, what products already exist, and at what cost are crucial steps when deciding on how to correctly price a product. Depending on what type of products you sell and industry you are in, market research will help you better decide how to price when you put your item to market.
The economy is constantly changing, and so is the cost of living. That’s why making an effort to periodically review product pricing is a must. Different laws, new competitors, updated technology, and rising costs are all factors that you have to consider when revisiting your price points and pricing strategies.
Continuously accounting for current expenses and future expansion, and using data driven analysis to monitor performance is vital in this regard. Cloud-based point of sale technology like KORONA POS that tracks and analyzes long term KPIs, customer retention, and conversion rates provides crucial sales data to help businesses determine what pricing decisions to make and when.
How to Calculate the Cost of a Product: 4 Strategies and Formulas
Many pricing experts warn against the pitfalls of underpricing or overpricing your product. Underpricing can lead to not only the obvious problem of cash flow but can also cause customers to view your product as cheap. Inversely, overpricing can cause potential customers to look to your competitors for better deals, shifting sales away from your brand.
Nonetheless, there are some tried and true formulas that work for calculating optimal pricing. They are not one size fits all and some strategies make more sense than others for specific markets, products, and customers.
1. Cost-Plus Pricing
Cost-plus pricing is the most basic way to determine what to charge for a product or service. For this method, you simply add up all of the true costs of putting together your product, then add the desired profit margin and arrive at your price.
Cost-plus pricing is effective in that it makes your company’s bottom line the main factor in determining prices. While this method is very simple and thus, easy to justify, it doesn’t take into account competition, and is not ideal for more saturated markets where many similar products are available. Typically, you are better off using cost-plus simultaneously with alternative pricing strategies.
2. Competitive Pricing
In highly saturated markets with a large amount of competition, companies will need to implement this pricing method. By surveying the prices of similar products in the marketplace, you can determine what people pay for specific products and how your product could potentially perform.
As an option that strongly relies on market research, competitive pricing situates a product within the consumer landscape. This gives you an idea of how your product stacks up next to others, and how you should price based off of that comparison. If you plan to signal a higher quality item then you can price just above your competition. On the other hand you can try to obtain market share by selling your product for cheaper than your competitor’s price.
Nonetheless, knowing what other people charge without considering what your product costs to produce can lead to obvious problems with your bottom line. Thus, as previously suggested, implementing competitive pricing alone should be used in conjunction with other pricing strategies.
3. Penetrative Pricing
To get into a market and win over customers, some companies will use penetrative pricing practices. This strategy involves offering very low prices to entice customers to buy from them and providing an experience or product that satisfies the buyer enough to stay with the brand.
For example a liquor store might advertise a popular whiskey brand at a price that is lower than any other shop around them, effectively making a much lower profit margin for said item. However, if this causes new customers to enter the store, survey other inventory, and leave impressed by the staff and service, they will likely make an additional purchase or come back again to purchase other products.
Penetrative pricing can be highly effective to get your business going but must be situated in the context of longevity and sustainability. Still, it won’t work as a long term pricing model. Few businesses can afford to operate on such low margins for an extended period of time.
Sometimes the value for an item on the marketplace is almost completely unrelated to the cost of its production. As such, companies will be in a position to charge what they believe a specific segment of customers will pay for specific products.
For example two different fashion designers might use the same materials to produce a piece of clothing, but that doesn’t mean customers are willing to pay the equal amount for both. The final cost of the item isn’t derived from a mathematical formula of the cost to produce + profit margin, but instead is based on the amount that the company thinks that people will pay for it.
If you are selling a product that is made by a particular designer or artist then the exclusivity of ownership can inflate this amount. Again, doing research and interviews combined with trial and error techniques allows businesses to maximize profits.
4. Price Elasticity
Finally, price elasticity must be mentioned here. In fact, it’s not only a pricing strategy but also a good indicator of how your brand is performing within the marketplace. To measure elasticity, you take the percentage change in quantity of sold items and divide it by the percentage of change in price.
For example, if you are selling sneakers for $50 dollars and you change the price to $60 the percentage change would be 20%. People in your store might be less willing to spend that amount so your total quantity of pairs of sneakers sold in a particular time frame drops from 100 pairs to 90 pairs, or 10%. Here you would divide 10 by 20 giving you an elasticity of .5. The higher the elasticity the more susceptible the product is to lower demand with price changes.
Some companies that offer exclusive or proprietary products will be near perfectly inelastic, meaning their sales will not waver based on price increases. Others, especially in saturated markets, might see a high level of elasticity as other cheaper options for near exact items are available.
Either way, elasticity it’s an important marker to look at when monitoring your pricing practices and measuring your company’s marketing and branding effectiveness.
Pricing with Your Retail POS
KORONA POS offers retailers powerful tools for managing their inventory. The software breaks down your store’s data into manageable reports, including customizable KPIs and ABC analysis. It also makes running a promotion simple, allowing you to track margins and overall performance. For more information on how your retail POS can help your pricing strategies, click below for a product demo.