How to price a product: 3 strategies proven to work
One of the hardest parts of building a product—aside from actually building the product—is deciding on its price. If you’ve spent a lot of time with a particular product, it can be difficult to gauge what it’s worth to others.
Do you apply a formula based on costs? Stick to the going market rate? There’s no single answer for how to price a product. And with so many factors to consider, figuring out the right price can often be the determining factor in your business's success.
To help simplify the pricing process, we’ve put together a list of the best strategies, as well as a few top tips, to set the right price for your product.
What you need to know before pricing a product
The purpose of finding the right product price is ultimately to turn a profit. This means after all expenses have been covered, there’s still enough money left to sustain and grow the business.
- Materials: Include the cost of every single component that goes into creating your product. For example, if you make chairs, your raw material costs might be lumber, wood screws, wood glue, primer, paint, and varnish. If you provide gardening services, you might need garden gloves, pruning shears, trowels, watering gear, rakes, and other materials. If you purchase ready-made products from another company, your material cost is what you spend for the product, plus anything else added (i.e., packaging, branding, etc.) to the final product.
- Labor: The majority of labor costs is your employees’ salaries—from production workers to admin personnel. Other costs related to labor are employee benefits and payroll taxes (i.e., health insurance, social security, etc.), which should be added to this category.
- Overhead: Overhead is essentially any other expense that isn't directly related to generating profits (i.e., anything that's not materials or labor). It’s divided into fixed and variable costs. Fixed costs are incurred no matter how much you manufacture or sell, and stays more or less the same each month. It includes rent, utilities, insurance, depreciation on fixed assets, and so on. Variable costs, on the other hand, are dependent on outside factors and fluctuate each month. These include expenses for marketing, office supplies and equipment, volume-based subscriptions, licensing and filing fees, and so forth.
Adding these three categories together will determine the total amount your business spends each month to produce all its product. To get a per unit cost, simply divide the total by the volume of products made each month to get your per unit break-even number. See the calculation below for an example:
Monthly material costs: $5,000
Monthly labor costs: $60,000
Monthly overhead: $25,000
Total monthly costs: $90,000
Number of products made per month: 10,000
Cost per item to break-even: $9
3 different strategies for how to price a product
Now that you know how much it costs to produce a product, it’s time to figure out how to price a product to earn your desired profit. There are three different pricing strategies that you can apply:
This is the most popular pricing strategy, as it simply takes the product cost, adds on a desired markup percentage, and sells the product for that price. For example, say your product cost is $9 and you want to add a 50% markup, which is $4.50 ($9 x 0.50). This gives your product a selling price of $13.50.
While this is a simple way to calculate prices, it doesn’t take into account other important details, such as branding or current market price. It also assumes that you will sell your entire product inventory, which is ideal, but may not be possible every single month.
This is essentially the opposite of cost-plus pricing, as it bases the price of the product on perceived value rather than production costs. If you know your market well enough, you can estimate the dollar amount your customers are willing to pay. For example, if you're confident your target market will readily pay about $30-50 for a t-shirt, this is the product’s value-based price, regardless of what the cost of your product may be.
To be able to charge a higher price than the standard market rate, you have to add perceived value to the product. Some effective ways to increase value are to offer added convenience (i.e., free shipping), customer service (i.e., 24/7 support), elevated branding, or simply a product that’s on trend and in high demand.
Competition-based pricing (market-oriented pricing)
Sometimes, it’s easier to look at the price of similar products already available in the market. From there, you can easily set prices at market, below market, or above market.
Pricing at market is basically selling your product at the industry standard price point. As long as you’re able to cover costs and maybe earn a bit of profit, this is a safe strategy to test out a new product or market.
Pricing below market attracts more cost-conscious customers, but also makes it harder to cover your bottom line. Setting a low price is good if you can manage to maintain a high sales volume, as well as cut costs and negotiate better terms with your suppliers. It's also a popular way for ecommerce and small business owners to attract more sales in a competitive market.
Pricing above market not only means increased profit and cash flow, but also indicates the high-quality and value of your product. This is a risky strategy, especially if your market is price sensitive and there are many similar products available. However, if you really do make a better product, this can be a beneficial strategy to set yourself apart from competition.
How to price a product to get the most profit
Oftentimes, having a pricing strategy in place is not enough. There are many other considerations, especially when it comes to appealing to customers and maintaining competitive pricing The following are some useful tips to keep in mind when setting a retail price:
Know your customer
To come up with the best price for your customers, it helps to know as much as you can about what they care about and what they’re willing to pay. In addition to learning the basic demographics, ask about other brands and products they use, what motivates them to buy a product, and any other factors that influence their purchasing decisions.
If you ever bought something you didn’t really need, simply because the price was too good to pass up, it may have been a product of psychological pricing. Years of retail research have shown that certain prices are better at prompting customers to make a purchase. “Charm pricing,” for example, places the number nine at the end of a product’s price. By changing the total even by one cent, from $5.00 to $4.99 (or even $4.79), a customer’s brain registers this as a better deal.
Experiment with different prices
Prices are not something that can be set once and forgotten. Costs fluctuate, markets change, and product pricing should be dynamic. To raise prices without receiving a negative response from your customer base is by offering some other value, such as a complimentary gift with purchase, free shipping, or product bundling.
The price is right
The strategies outlined above are a great start to pricing your product, but it’s also important to carefully consider your own business and market. As long as you make sure to cover your monthly costs, the possibilities for how to price a product are endless.