The Ultimate Guide to Product Pricing – Key Factors to Consider
Product pricing is one of the most complex decisions for companies to make when launching a new product, entering a new market, or increasing their share in the current market. Many types of pricing strategies are present in the business world. In the sea of different pricing models, as a business owner, you must find the most suitable one. The process of product pricing is complicated, constantly changing, and is based on many pricing factors.
If you are considering introducing a new product/service or just making price changes to the existing ones, here are the key factors to consider for creating a higher profit margin.
1. Identify your Product Pricing Goals
Regardless of whether you’re an enterprise, or a small business, without a business goal you can’t succeed.
The first step is to be clear about what you want to achieve with your product pricing strategy. Is it maximizing profits? Or maximizing market share with your products?
For example, one of your goals can be to maximize market share with your product. That might result in a cost decrease or in what economists call “network effects”. The value of your product increases as more people use it. While listing your goals, you need to understand that prices aren’t enough to drive sales alone. That’s why it is vital to be aware of your ability to sell and avoid making poor pricing decisions.
The most common product pricing goals:
- Maximize profits (usually by increasing your margins & consequently the price)
- Maximize sales (be the cheapest or among the cheapest sellers on the market)
- Penetrate new markets (requires aggressive price slashing most of the time)
- Adjust prices over time (e.g. price skimming – start with a high price and drop it gradually)
- Cover your costs (mainly applied during turbulent economic times when the demand is in decline)
2. Know your Costs
Product pricing comes after you learn everything about the costs of running your business. The first thing to think of when developing a product pricing strategy is to cover your costs first and then consider the profit.
Fixed costs: Regardless of how much you sell, it is the cost that you always need to factor in. For instance: rent, labor costs (salaries), materials, etc.
Variable costs: This type of cost mainly covers extra things. Those are additional materials, labor, transport, etc. Therefore, they can fluctuate over time. Most often, as your production/sales levels increase, so will your variable costs. This will inevitably also influence your product pricing. Once you calculate the cost of producing your product and service, you must set a higher price than the variable costs. That’s the only way to make a profit and ensure cash flow.
3. Know your Customers
Another important aspect to consider when setting the product pricing strategy is the customers. It is vital to investigate what the customers want from your product or service. Are they driven by the cheapest version available? Do they equal higher product prices to higher quality? What role does the price play in their purchasing decision?
Answering these questions will give you a better insight into who your audience is and what should be your selling price.
But how can you learn more about your customers?
Your research can start from informal online surveys sent out to your already existing client base. You can also hire a market research agency to conduct this research for you. Therefore, you’ll know if you are targeting the right group. Then you’ll be able to decide what would be the most suitable product pricing strategy for them.
In a way, understanding customers also starts with knowing your product’s value proposition. What is it about your product that makes someone’s life easier? Do you have a way of creating the same product as the one on the market, but at a lower price? Once you know your core value proposition, you’ll be able to understand your target customers even better.
4. Market Positioning
Understanding your customers is also important when it comes to deciding what should be your market position. You need to make a decision. Do you want to be the most expensive? The most luxurious or high-end brand in your industry? Or maybe you want to be the cheapest one? Of course, you can always choose to be somewhere in the middle. Those are all different price points.
Why it is so important to decide in which direction you’ll go?
The price that you set for your product or service will create a brand perception in the eyes of your potential customers. For example, you can position yourself as a low-cost leader, where customers will know that low price is your strongest weapon.
Here it’s also important to consider customers’ expectations. If you’ve done your research from step 3, you’ll most likely have no issues with this. Exceeding expectations is desirable because delighted customers can turn into evangelists of your brand. Word of mouth from genuinely impressed customers is one of the most powerful tools for growing your brand.
5. Product Value
What is your product worth to your customers? Does it save them money or time? If that is the case, then you can base the price more on its value for customers instead of minimally exceeding its production price.
Many factors should be taken into consideration when deciding on a product pricing strategy. Therefore, it would be useful to run a few pricing calculations to come up with the best solution.
Pricing calculations use a starting point:
Cost-plus pricing: this should be your minimum price. You need to set a price that will cover your production costs. After all, you aim to make some profit.
Fair pricing: no matter how good or useful your product/service is, no one will be willing to pay for it if they find the price unfairly high
Value-based pricing: as we have already explained, this should be your maximal price. This means that your production costs are only part of the equation. You’ll need to have a solid understanding of your customers and the value your product provides. This is a crucial factor that should determine your price.
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6. Market Research
Market research is necessary to decide how much you are going to charge for your product or service. For products and services already available, market research can tell you if you’re on a good path. For example, while conducting market research you can use the results to create a business plan.
Another option is to measure the success of your current plan. In a simplified way, this is done by going back to the goals and KPIs you’ve set. From there, you’ll know what has been fulfilled and what hasn’t. By seeing what’s going well and what needs some work, you’ll identify important points that you can benchmark against your competitors.
The next key component of market research is comparing your prices against your competitors continuously. That way you’ll discover underlying profitability every month.
However, checking out the overall profitability of your company every month is not enough. You have to focus on the profitability of every product you sell. That means you have to analyze your product pricing one by one. Such a great analysis usually takes a lot of precious time and effort to perform.
Fortunately, you do not have to spend endless hours doing it. Instead, price monitoring tools like Price2Spy are a great way to track competitor prices, stock assortment, and other valuable information about your competition. Also, they help you determine product pricing opportunities, by following your own set of rules.
Moreover, you can use price monitoring tools when it is time to segment your market. The more data you have (ie. the more monitoring you’ve performed) means a solid foundation for precise segmentation. Differentiating your product or service from your competitors can also be done with the help of our tool.
After everything is said, we can conclude. One of the most important things to focus on is listening to your customers. The second one is to keep track of your competitors. And finally, have a budget action plan in place. Remember, to maximize profitability, you must achieve balance. That means finding an optimal price.