The Art and Science of Pricing Your Products

The Art and Science of Pricing Your Products

Table of Contents

One of the toughest thing to do in business, if you want to succeed, is setting the right pricing for your products. Many people consider this feat a place where science and art transcendent. When you price your products or services correctly it can influence how much will you sell and so if your business will be sustainable over longer period of time. On the other hand, get your pricing wrong and all your effort invested in your business will go down. Will you put your business at risk?

In business, there is a variety of types of pricing strategies you can use. However, what you need to understand is that there is no one-suits-all solution or formula-based approach working with every type of product, business or markets imaginable. In order to set the right pricing for your products you will have to consider some key factors. These factors include understanding who your target customer, analyzing how much your competitors are charging and also understanding the relationship between price and quality.

You Do it For Money

Before going any deeper into the art and science of pricing you must be really clear about what the goal of developing your pricing strategy is. Put simply, you want to make money. This is the reason, or at least one of them, why you are in business. If you feel bad about it for whatever reason, don’t. Making money by selling your products, services and so on is a good thing. Without money it would be much harder for you to help other people. Profitability will also allow you to provide better products and services to your customers and perhaps expand your business furthermore.

One of the biggest mistake many entrepreneurs make is to believe that price alone will drive sales. Understand that it is your ability to sell, hiring the best sales people and implementing the right sales strategy what drives sales. In other words, the selling price is a function of your ability to sell and nothing else. For example, think about visiting a car dealer. You are comparing two models of cars from different brands with different price points. What will be one of the most influential factors for your decision?

Well, it will be the sales person’s ability to sell you one of these cars. What will matter, in our example, is how the cars will be presented to you. Do you remember the time when you bought our last phone? What was the reason you bought that specific brand and model? Was it a review in media, recommendation from your friend, power of that brand, or sales person in the store? Anyway, if you want to be a Samaritan, be it. However, it will be easier for millionaire Samaritan to build dozens of schools and shelters for homeless.

Going Under or Over

When creating and implementing your pricing strategy, there are two dangerous traps–over pricing and under pricing. Both of these dangers can be the last nails in the coffin for your business. Let’s take a look at both of them.

Under pricing means that you are pricing your products for too low. Wait a minute. What is too low? You can either set the price so you will just meet the break-even point and keep your business afloat or you will end up with loss. Understand, being able to set pricing accurately is critical, no matter what cycle the economy is. When talking about economy cycles, many entrepreneurs have higher tendency to under price their products. They do it to convince the customer that their product is cheaper and so he will buy it in bulk.

Unfortunately, what your customer will see is just a product that is “cheap”. Remember that customers want to feel that they are getting appropriate value in exchange for their money. If you offer them a product they believe is less valuable, they will be less likely to buy it. You need to be careful that you are covering your costs when pricing your products. By setting the price below the cost of production, you are making a mistake condemning your business to slow death.

On the flip side, over pricing your product or service can be also destructive. Remember that the majority of buyers will compare your prices with your competitors. What do you think the customer will do if he will see your product available elsewhere for lower price? Understand that on the market there are two forces on the market determining direction. First force is demand and the second is supply. If supply is higher than demand, there is more products than people want to buy. When there is higher demand than supply means insufficient amount of products.

There is also third state called equilibrium. This is a situation when demand and supply are equal. For most of businesses, this equilibrium is where they want to be. This situation means that what you put on the shelf will be sold, no leftovers in stock. Some of you may argue that higher demand than supply is also good for you. Well, not so fast. If this case is true in your business, you are pricing your products lower than your customers are willing to pay–you are under pricing.

When releasing new product or service, entrepreneurs are often tempted of pricing it too high. They think that they have to cover all the expenses like employee wages and so on. Think about it from the point of your customer for a moment and ask yourself one simple question. What would be a fair price to you? Even better, you can create a little survey to gather feedback on your pricing strategy from your customers to learn about their view. The average will give you the best idea of what the price point for your product should be, no emotion attached.

Takeaway: Price of your product creates certain image of its quality, value and what it is worth.

What are the Priorities of Your Business

When creating a pricing strategy you have to understand what do you want to achieve. For example, one of your goals can be to increase the market share with your product. On the other hand, you may want your product to be known for its quality and so, you may want to price your product higher to reflect it. There can be dozens of other priorities that will play role in setting your pricing strategy. These priorities may also change as time goes, make sure to stay flexible.

Takeaway: Price is much more than just a number on the package. You have to know your business priorities and adjust you pricing strategy accordingly.

Know Your Customer

The first thing you have to make sure is to undertaking who your customer is. What this mean for you is to spend some of your time doing a market research. Examples of this research can range from informal surveys that you can send in e-mail, putting together a focus groups or getting out of the building and asking potential customers directly on the street. No matter what approach will you choose, your goal is to create a customer persona. One of the things you have to understand is the budget of your customer. Knowing what segment of customer you are targeting will make the whole process of creating the right pricing strategy much easier.

Takeaway: Knowing your customer is crucial to set the price right.

Know the Costs

A fundamental principle of pricing is that you need to cover your costs and still have some money as a leftover–being in a profit. Meaning, you have to know how much your product costs. You also have to understand how much you need to mark up the product and how many you need to sell to turn a profit. Remember that the cost of a product is not just cost of the item, but it also includes the overhead costs. These costs may be fixed, such as rent, or variable, such as shipping or stocking fees. Don’t forget to include these costs as well. A good rule of thumb is to create a spreadsheet of all the costs you need to cover every month.

This spreadsheet can include things like your actual product costs (wages, marketing), operating expenses necessary to keep your business going, any costs associated with debt, your own salary as the owner, capital for future expansion, capital for maintaining your physical assets or buying new ones and more. The total should give you a good idea of what revenues you will need to generate in order to make your business sustainable.

Takeaway: In order to create sustainable business, you have to know where are the money going.

Set Your Revenue Target

Next thing, after knowing the costs you need to cover, is having clear idea of your target revenue. In other words, how much of a profit you want your business to make. To do this, estimate the number of units of that product you expect to sell over specific period of time and then divide your revenue target by the number of units you expect to sell. The result will be the price at which you need to sell your product in order to achieve your revenue and profit goals. In case you have more products to sell, you need to allocate your revenue target by each product.

Takeaway: Without setting specific target you are going blind.

Learn from Your Competition

Another thing that can help you set the right pricing strategy is looking at the competition. If the products you are selling comparable to your competitors’, you can use their pricing as an initial stage. Next, look where your product is different, where it adds more value to the customer. For example, do you offer some additional service? Is your product perceived as a product of higher quality? If the answer is positive, you may be able to set a higher price without over pricing it.

Takeaway: Use your competition as a resource to learn from.

Understand the Market First

In order to set the right pricing strategy you should keep track of outside factors that will impact the demand for your product in the future. These factors can include many things, some of them you may not even consider at first. For example, if you are selling season dependent products, weather patterns may impact the future sales of your products. Future changes in legislation can also create changes on the market and so influence your sales. You also need to take into account your competitors and their actions. For example, what will you do if your competitor will respond to your presence by starting a price war?

Remember that your product price should never be the same. It should vary depending on various factors. These factors include what the market is willing to pay, how your company, brand and product are perceived by customers, what are your competitors charging, whether your product is shopped frequently, what amount of product you can sell and so on. All of these factors can be an opportunity to raise or lower prices for your products. However, in order to make the right step, you have to understand what is already working.

This means you should analyze the profitability of your existing products to find, first, what you can do more of and, second, what you should be doing less. Your goal is to find out which of your existing products are making money and which ones are losing money.

Takeaway: In order to set the right pricing strategy, you have to understand the environment first.

How to Raise Your Prices

One thing every entrepreneur and business owner should do is to always test new prices and offers. You should try and test new combinations of benefits and premiums to help you sell more of your product at a better price. The frequency of these test can vary depending on the type of your business, but trying something new each month is a good place to start. These experiments can include actions such as raising the price and offering some new unique bonus or service for your customer. At the end of the month measure what effect the experiment had on sales of your product. Where the changes positive? Implement them, otherwise move on.

You should understand that this experimenting with pricing strategy should not be forced as something required. Meaning, if you never raise your prices, you won’t be in business for long. In every business you have to constantly monitor your price and your cost so that you are both competitive in the market and you make the kind of money you deserve to make.

If you are still not sure about how you can determine if the price is set correctly, just watch sales volumes immediately after making the change. Gather the data about your sales and profit you make for the next month. If you increased the price too high, customers will react pretty quickly and you will be able to spot this reaction in your data. Also, make sure you are watching your competition. If the reaction on change in price is positive, competitors are likely to follow you.

That being said, you should not change your pricing model as you wish. There is a right way and a wrong way to raise prices. Remember that you don’t want to alienate your existing customers by raising prices too steeply. Instead, you should come up with strategic plan you will follow over longer period of time during which you gradually increase your price by specific percentage. Five to ten percent is good range to stay at. Also, raising price is more accepted times are good. In these times, your customers will be prepared to accept the rise in the price.

Takeaway: Raising prices should always follow a specific plan and long-term strategy.

When You Need to Lower Prices

At some point you may realize that you have made a mistake by pricing your products too high. First, don’t think about it as a catastrophe or that everything is lost. You can always choose to offer a discount or give customers something for free to balance the situation and convince them to try your product. Remember, people will always appreciate and like getting something for free or some kinds of discount. What is great on this approach is that you are keeping the price the same while taking a chance to expand your customer base without any need to lower your prices.

In majority of cases, lowering prices is not a good business practice to follow. Unless you are using it as a strategy to increase market share and your customer base you should stay away of it. Another situation when lowering prices can be considered usable strategy is if all of your competitors are lowering their prices as well. One alternative to lowering price is to offer less for the same price. This will reduce your costs without appearing to reduce the value to the customer.

Takeaway: Instead of lowering prices, try use discounts, special deals or offer less.

Monitor Your Pricing

The last key component to pricing your product the right way is to steadily monitor your prices and your profitability on a monthly basis. Remember, it’s not enough to look just at the overall profitability of your company every month. That would never give you the whole picture. You also have to account the profitability, or lack of it, of every product you are currently selling. To make your business successful, you have to make sure you know how every product you sell is contributing to your goal of making specific amount of money each month.

Takeaway: You cannot improve what you don’t measure.

Tips to Set the Right Price

Before leaving you, I want to give you few short tips on how to come up with the right pricing strategy. First, listen to your customers. Make gathering and analyzing feedback from your customer on a regular basis about your pricing part of your schedule. Doing this, you will also show your customers you care about what they think. Second, keep a close eye on your competitors. Invest in market research team and monitor what your competitors are doing. Third, have a budget action plan in place. Meaning, implement a plan for your pricing for about six months in the future.

Closing thoughts on pricing your products

In the end, money are life-giving blood of your business. The only way to make money and create sustainable business is to be relentless in managing pricing strategy of your product. Remember, the way you set the price of your products could be the difference between the success or failure of your business. Do not leave this to chance.

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By Alex Devero

I'm Founder/CEO of DEVERO Corporation. Entrepreneur, designer, developer. My mission and MTP is to accelerate the development of humankind through technology.

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