How to Price a Product – The Ultimate Product Pricing Strategy Guide for Small Businesses

Cody Cromwell
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Understand the Basic Terms & Math of Product Pricing

Before you can understand what products to price and how to do it, you need to know the basics of economics and the way price is determined by business.

The formula for determining the selling price of a product is (wholesale price of the unit) x (added value percentage of the added component) / (wholesale price of the unit).

Added value can be provided by the use of a product or a service.

For example – the price of a banana (a unit) X 25% (added value) price of the peel would be R38. An apple would be R170 X 15% = R21.

When you use the formula, you should be mindful of the math. Let’s talk about this with a new banana example.

A) The wholesale price of a banana is R30.

B) The wholesale price of the peel is R10.

C) Therefore, if your added value is 25% per unit, you should charge the wholesale price, R30, per unit with the peel included. The retail price, R60, which includes various taxes, should then be added on to this wholesale price.

An added value percentage can be calculated using the formula (total value added / total production price) X 100.

Let’s look at this with the same example of the banana.

Markup

It is $XXXX to produce your product; divide that by the number of units you made to arrive at your wholesale price.

Why?

Markup is how you set the price. If you set your price too high, you’re going to lose money. Set it too low, and you’ll have to do a lot of work to make money.

Difference between Price and Cost

If you price your product based on cost, you’ll end up with a higher retail price than what you really need to make money.

Easy to Understand

It’s easy to understand and there’s no arguing with it. Problems occur when you don’t use the right tools or techniques. Be sure to pick the right tool or source if you’re not using retail pricing.

Most Importantly: End User Meets Cost

Over time, you’ll develop a good understanding of your cost and can use that to set your price on your retail product.

In order to determine your price, you need a way to figure out what your cost is. Without knowing cost, it’s impossible to set a fair price and make money.

Profit Margin

Markup vs. Profit Margin – Which Will You Use?

The only way to generate a positive revenue is to mark up the product above its cost. This is also called the mark-up percentage. The margin is the additional amount that you need to cover to compel you to earn the desired profit.

The key to pricing your products is to increase your margin by offering discounts. You can also offer other items for free as a part of an inhouse promotion, or when

It is profitable. But this is only applicable to some maximum margin items.

It is a doomed concept to give away a product at a very high margin and expect your small business to earn profit.

You can only trade off your margin by offering the products at a discounted price. This will help you gauge the exact margin and profit that you are going to make.

The quantity of your business or the demand for your product is another factor to consider while finalizing the pricing.

Therefore it is pertinent to know what you are offering for the customers. To price the products one must first know few dynamics that affect the demand and rate of price increase.

The above factors largely depend on the competitors' prices. If the competitor is far away from the price range of your product, you can cannibalize their business.

The quality of your product will also influence the price factor. If a high-quality product is selling low at a low price, consumers will definitely shun it.

Know the Common Pricing Strategies for Your Industry

Whether you’re starting out or have been in business for a while, chances are your pricing strategy is more common than not. You’ll want to know this information once you’ve decided that a larger company is not what you are looking for.

With the amount of products the average small business generates, it might seem passing strange that price should be a deciding factor in your business operation. But it truly is; you’re the one selling the product, after all.

The strategy for pricing your product should complete the other aspects of your business. If your business modus operandi is to provide a great product at a fair price, this strategy should be a good fit.

However, you’ll want to worry less about pricing the item and more about the company: How you set it up, how you market it, and how you provide a great product will run the show.

Now, if you’re the one putting together a budget for the year, keep in mind that average income follows the price of products. The New York Times published a story in 2012 outlining a sample budget for the average American household. Among other important expenses, the extra income a consumer might have received from low gas prices would also have had an impact on the decision to spend money in other areas.

Keystone Pricing

A keystone is a type of arch or a simple T-shaped stone placed upon a stone or wall foundation. Keystone pricing is a pricing strategy where your selling price is set at the high end of the price range for your product.

Keystone pricing is becoming increasingly popular, and it’s a useful pricing strategy for many high-margin businesses.

Keystone pricing helps small business owners better achieve an overall average margin close to industry average margins.

Keystone pricing drives up the perceived value of your product. Because your product is generally perceived as being less expensive than competing products, customers will pay more for your product and this drives revenue.

This pricing strategy allows you to lower your margin to a lower level because you only need a small margin to run your business. While this is good for your business, you must be sure that you’re maximizing your profit margin by carefully managing your expenses.

MSRP

Companies sell a lot of products, and yet with so much competition out there fooling an average buyer is not feasible. Price drills are often a key weapon for a company when they are out to compete for a new customer.

If you are a small business, you need to get MSRP price on your items. The problem with MSRP price is that, once you get it, it doesn’t mean a lot to your customer.

Price is not only related to product and product prices, but also to the perception of the customer. A customer who is not aware of your MSRP price will not give importance to it if you can prove him that it can fit his budget.

How to Get The Most Out Of Your MSRP Price?

In order to balance your price range, create a campaign that will incorporate the MSRP price with the objectives of your business. For instance, if you are selling shower gel, create a campaign of a bonus shower gel with your logo, or with an additional product that will be of interest to your customer.

In the same way, if you are selling a product that has a manual, include those for free. Show the customer how your product works and how to maintain it.

In short, MSRP price is the introduction. It can become the extra money that will persuade them to buy.

Psychological Pricing

Psychological pricing is the strategy of setting your lowest price – or sub-1 cost – to generate more inquiries and increase the chances of converting a customer. The low price is also used to build trust, earning the customers‘ loyalty.

The Anatomy of a Low Price

Red flashing price … what is it?

Red flashing price is used to get people to buy. It usually appears for a short time before the final price, which is more attractive than what the buyer previously saw. The reason for this is that people are prone to act on what they see rather than what they hear.

How to design a low price?

Below are a few tools and actions you can implement to help you design a low price in your website.

  • Use a reduced price discount tool.
  • Use a visual preview to make the price more attractive.
  • Create scarcity by offering a limited number of discounts.
  • Use a specific price breakdown.
  • Use urgency to increase transactions.
  • Use a note to complete the sale.

Variables to Optimize

The risk for the buyer

Create risk in the minds of the customers and reduce their hesitation to buy.

Use a coupon or special offer to increase the risk and create an obstacle to considering the product as an impulse.

Discount Pricing

This strategy is used by businesses that sell close to the wholesale price, but sell for a better price than the competitor.

In this strategy, you adjust the price up or down in order to keep the difference between the actual price and the price below the competitor’s price at a level that gives a profit.

This strategy puts you in a very delicate situation because you must know when to increase the price AND when to decrease the price.

If the price of the product is increased, the product will sell very slowly. If the price is increased, the customer will not purchase the product because it is too expensive. This pattern will make the actual product price get closer to the competitor’s price.

In this case, the competitor’s price is the price you must keep. Then if you decrease the price, the customer will not purchase the product because of the low price, but the actual price will raise to the competitor’s price without making any profit for you.

These are the main risks of this pricing strategy and it’s not recommendable.

Pricing Strategy

Basing on the structure of a product’s life, we can categorize them into one of five kinds, which are:

a product that has a longer life

Loss-Leader Pricing

The infamous "loss leader " is a tactic used by retailers to direct customers to their stores. This is an effective method of attracting customers. If a customer continues to buy from a company and the company repeatedly offers the customer an item or service at a loss in profit, the customer’s loyalty is encouraged and the customer will continue to return for more frequent purchases. Loss leader pricing is usually used on items that have a high profit margin but are necessary for the operation of the business.

This type of pricing is often circular, meaning the item is ultimately purchased by the customer at little to no profit to the store and the store makes its profit on the item by the time the customer takes it home and uses it.

When used in a business, the loss leader is often an item that does not have a large profit margin but instead has a large profit margin which quickly returns to zero or minimal profit. The store will still make more than enough profit from the other products they sell, so the loss leader is seen as an effective way to make customers come into their store.

Anchor Pricing

In pricing your products, it is important to be aware of the differences between two pricing strategies …Anchor pricing and Discount pricing.

Anchor pricing is when a high or low price on your product is paid by customers in the first few months of its release to establish it as an anchor price point for future development. In demand, high end products are generally sell for a premium price meaning the more efficient your production is, the less you can charge per unit. With that in mind, you want to keep all of your development costs as low as possible from the start to ensure a profit.

With few competitors, the industry standard is to raise your price to establish your company and product as a reputable, market leading brand. In the early days of a product’s market introduction, there will be a risk of negative publicity and sales due to the newness of your product. With that in mind, you should price according to the competition to ensure comparable barrier to entry and market share.

Cost Plus Pricing

Price setting has always been one of the most challenging tasks for the entrepreneurs. We all want to set the price for the product at the optimum price point to get maximum sales or at least at a price point which is justified by the cost of the product. In case, you don’t want to price the product too high as it may not have any takers leaving you with most of the profit while in the worst case it may kill the sales.

There are a few pricing strategies which a small entrepreneur can follow to set a price for his product. Some of them are simple while some are a bit complex. The pricing strategy depends on the size of the company and the nature of the product.

There are two basic types of pricing strategy which are target cost pricing and cost plus pricing. Though they are essentially different in nature, target cost pricing could be considered as the subset of cost plus pricing.

Cost plus pricing: It is a product price which is at least equal to the cost of the product. The costs involved in manufacturing and distributing the product are taken into account in the price decision.

Target cost pricing: The product price is set based on the goal of selling the product, and the cost of doing this is often a closely-guarded secret, though there are versions of target cost pricing that make the cost public.

Choosing the Best Pricing Strategy for Your Small Business

Pricing is a tricky thing to get right, especially if you’re working off a small budget. Before you set your prices, you need to identify your pricing strategy.

Pricing strategies can be broken down into two categories: cost based and value based. Since you have a small business you should focus on value based pricing.

Cost based pricing is used in larger companies since they have the money to bear the costs. Smaller companies like you can use value based pricing to differentiate your product or service from your competitors and reassure your potential customers that you have features and benefits equal or superior to their competitors that come with a lower price.

Value based pricing is simple – it’s a comparison between two products, with your product having a lower price. You need to identify your major competitors, and then find a way to give your product a unique advantage or service that your competitor doesn’t have in order to set a lower price. Perceived value and added value are both terms you can use in order to give your product a higher value than the competition.

When choosing a pricing strategy, there are a few questions you’ll have to ask yourself:

Is my product of a different quality than my competitors?

Make Sure Your Product Pricing Strategy is Profitable

It’s true that product pricing should be as profitable as possible, or at the very least, close to break even. But it’s also true that attracting customers and increasing sales is central to your online business.

Profit is a nice thing for an investor in a company, but nothing is more important than making sure that your product pricing strategy is profitable.

You need to make sure that your pricing strategy is profitable by figuring out what makes you different from your competitors and what will convince your potential customers to buy from you.

We’ll cover those in the next section.

Raise Your Prices

The whole point of owning a small business is to increase profits or, at least, to minimize losses. If the total amount of money you spend equals the total amount of money you take home each month, then you’re legally operating your small business as a small business. You must pay your mortgage or rent, which will include utility bills and insurance costs, of course. You also need to pay for employee salaries, possibly employee health insurance or business-provided health insurance, and a business phone. From there, however, you are free to spend as much or as little money as you want.

Business owners mistakenly believe that raising prices in their small business will make their profits tank. Of course, the more money you make, the more money you’ll have to put toward increasing your business’s chances of success. If you want to increase profitability in your small business, you have to charge enough for your products so you can make more money than you spend on them. So what does that mean?

It might make you uncomfortable, but raising the price of your product to increase your profit is a smart business decision. In fact, you can improve your profitability by charging more for your products without losing any customers.

Increase Your Volume

Whatever business you are in, one of the most important things you have to do is make sure that you also sell at a high price. If you practice good pricing strategy, you can increase your company’s volume and profit by as much as 100%.

But on the other hand, where do you start? There are a number of strategies you can use to produce the right product for the right price. You can create daily deals, drop shipping, upselling, cross selling, scarcity and more according to your company’s needs. And once you make it your sales goals, you have to make sure to track their effectiveness.

Sound complicated? It’s supposed to be. Because sales management isn’t easy and relies on detailed strategy and planning. If you don’t have time to create a perfect sales pipeline, it’s better for you to use the proven methods that we will now discuss.

Lower Your Costs

In The Ultimate Product Pricing Strategy Guide for Small Businesses, author Roy Tucker shows you how to lower your costs to the buying customer in order to win more sales, grow your business, expand your market share, and increase profits.

Some experts claim that the average business costs 40% more to the customer than necessary. Tucker shows you how to get that number as low as possible, which starts with understanding the competitive environment in which your product competes. You must also make the product one that your customers will love. You can do this by focusing on what customers absolutely need in your product and what they can’t do without it.

Once you have this information, you can then determine if you’re in the right product category, how much you should sell with shipping included, and how much your top selling product should cost. This will enable you to price your product so that you not only give your customers a good deal, but also grow your business.

The Bottom Line

To figure out how much to charge for a product, you need to know how to match the product and the market.

To determine the selling price of your product, we need to apply two different losses.

The first loss is the opportunity cost.

The second one is the fixed costs.

As the product owner or the manager of a manufacturing company, you need to decide on a price that will cover the above full costs.

In other words, a price that establishes a profit for you and also provides an incentive for customers.

You can set the product price at the maximum price, and then you will have a loss in the market.

The best way to set that price is to set it based on the lowest price that the consumer is willing to pay for the product.

We can easily determine the price that the market will accept by averaging the prices of all customers.