The formula to set a price is easy. First, sum up your costs per unit. Then, add a reasonable profit margin.
But what goes into these numbers isn't quite so straightforward. There are direct and indirect costs to consider, and you'll need to factor in customer perceptions of value, the psychology of pricing, the comparisons of your offerings to competitors, and the art of ensuring your products align with where your market is heading.
In this article, we’ll help you simplify the process and set up a price strategy that will help you thrive in your market.
Let’s talk costs.
Before you set a unit price, take time to understand what you’re investing into each piece.
You may have input, labor, packaging, and transportation costs that you can directly assign to a piece. But what about the other expenses? Think about the costs of running your business: taxes, real estate, utilities, software, office personnel, marketing, and the other expenses that are necessary to create your solution.
By accounting for these costs, you can set prices that help you make money rather than lose it.
Need help tallying the costs of running your business? Consider working with an accountant. Check out some of our favorite business-friendly firms here:
What about profit margin?
Profit margin is the amount of profit (or income after expenses) you aim to make per unit that you sell. There are no rules on the profit margin you can set, though you can find common practices in most industries.
For example, NYU Stern published this list of margins by sector, which can help you spot the average profit margins for your industry.
How do I work these elements into a pricing strategy?
Your pricing strategy will help you determine how much of a profit margin to set so you can position your business favorably in your market. There isn't a one-size-fits-all strategy. Instead, you'll need to find an approach that works for your business.
You might choose from one of the following options:
With cost-plus pricing, you’ll tally all of your direct and indirect costs per unit. To do this, you’ll sum the total costs of operating your business and divide that figure by the number of units you produce over the same time period. Then, you’ll determine how much profit you’d like to make per item and add that to your per-unit costs.
Here’s what that might look like for your business:
Let’s say you’ve spent $100,000 this quarter producing your solution. During that time, you’ve created 5,000 units. Your costs per unit are $100,000 / 5,000, or $20. If you want to make $10 in profit on each item (which is a 50% profit margin in this instance), you’ll set your price at $30 per unit.
This approach is simple to calculate and execute, but it doesn’t account for what your competitors are doing or what your customers think about your product relative to other options.
For this reason, many owners also consider this next approach.
Here, you’ll start by looking at the pricing of what’s available in the market. You might try finding the average price of a product or service you’re selling and decide whether you want to position your solution as a higher-end alternative, a mid-range offering, or a budget-friendly option. Then, you’ll set your desired price accordingly.
Finally, you’ll name the profit margin you want to earn. These decisions will help you find how much you can afford to spend to create or produce your solution.
Here’s how it works:
Let’s say you’ve scanned your market and see that the average solution is $1000. You decide selling at this price point makes the most sense for your business.
You decide that you want to attain a 50% profit margin on your product, so you know you cannot invest more than $500 to create or produce your product ($1000 x 50% = $500). If your costs are higher than $500, your profits will decrease. If they come in lower than $500, your profits will increase.
While these two strategies are the most popular, there are other options to consider:
With this option, your primary focus will be on your competitors’ products or services. You’ll set your prices higher or lower than what exists in the market according to how they stack up in terms of features, novelty, availability, or appeal to the customers you’re trying to win.
|You can use tools to monitor competitor pricing. Popular options include PriceManager and Minderest.|
This pricing option usually works best for businesses with three tiers of products: a feature-rich option, a streamlined choice, and a bare-bones solution. Your first option will have higher prices than the average product in your market because it provides more value. Your mid-tier option may match the average prices of the market because, in most ways, it’s a like-for-like comparison. And your bare-bones option may be priced lower than the average price of the market because it cuts out certain value-add features.
Dynamic pricing is a much more rigorous process. Your prices will fluctuate based on demand and may change many times throughout a quarter, a week, a day, or even an hour.
This model tends to work best for commodity products where price is, most often, the deciding factor for consumers. And while it’s difficult to implement, tools such as Quicklizard or PredictHQ can help you set and manage dynamic pricing parameters.
If you follow this strategy, you might set your prices low when you enter your market. But, as your market and awareness of your product grow, you’ll increase your prices and shift more toward showing the value of your products than trying to position yourself as the budget solution.
You can experiment with all of these options by using a product pricing calculator or by working with a fractional CFO experienced in product pricing.
Would you like to connect with a fractional CFO? Take a look at a few of our favorite firms:
Can I win if I set my prices the lowest?
This is a strategy many new businesses use to try to win customers, especially in their early days of operations. The problem is that it isn’t sustainable, and it’s quite unlikely you’ll be able to both cover your costs and turn a profit by doing so.
The businesses that have the most success with low prices are often those with tremendous scale. They can afford to make a smaller profit per item because their volume is so sizable.
But, if this strategy appeals to you, you might experiment with some of the following options:
With this strategy, you might set artificially high prices for your products and then “discount” them back to (or just below) your target price point. This approach sometimes works well for price-conscious buyers who value a great deal above all else.
Loss leader pricing
You might set the price of one of your most appealing items at cost (or even slightly below) to draw customers to your business. Once they’ve engaged, you can try to cross-sell or upsell your more profitable products or services.
Do I need to commit to a pricing model?
No. In fact, your pricing strategy should be dynamic because the needs and preferences of your customers are in constant flux. Make it a practice to set prices, test them, and document your successes with new strategies.
Some ideas could include:
- Raising the prices of your most popular products.
- Offering seasonal discounts to drive the sales of certain products.
- Learning and mirroring some of the most effective strategies your competitors use to win business.
With every strategy you try, monitor changes to your sales volume and profitability to determine which options work best for your business.
At the same time, ensure that you’re covering your costs and, where possible, make at least a small profit on every item you sell.
Are there any tools that can help?
Yes, there are a few that other business owners like to recommend.
If you have a service-based business, check out ServiceTitan. It offers price insights through its Pricebook Pro tool, which lists a variety of services pros like you may offer and the average price each sells for in your region.
Sell a variety of products? Check out Minderest. This tool will help you monitor competitors' prices and optimize your own dynamically.
Of course, there are ways to get personal, professional advice on the prices you should be setting. It's a great idea to consult a business coach for guidance. You could also reach out to your local SCORE office or Micromentor for free advice.
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