- 5 factors that affect a product price
- Two common methods to price your product
- When should I adjust my pricing?
How to calculate the optimal selling price for your product? What factors to consider? When is it OK to raise prices? These crucial questions pose a real challenge for beginning businessmen. However, product pricing doesn’t have to be intimidating. This article provides a roadmap for pricing your product. Let’s get into it!
5 factors that affect a product price
A product price is determined by a plethora of factors which can vary depending on your sector and specifics of your business. We’ve pinpointed 5 key factors to consider when setting a selling price for your product.
1. Variable costs
Variable costs refer to the amount of money you need to manufacture and/or distribute a product unit or service.
- For manufacturers: Calculate how much it costs to produce a unit of your product. Consider the cost of materials, tools, manufacturing, packaging, shipping, and marketing.
- For resellers: Calculate the purchase and shipping costs.
- For service providers: Estimate the perceived value of your service and determine your hourly rate.
Variable costs make the minimum price you need to charge for a product unit to break even.
2. Fixed costs
Fixed costs have nothing to do with the manufacturing process, number of units produced, or market situation. Fixed costs include rental payments, utilities payments, taxes, staff salary, loan payments, etc. Keep in mind that your sales revenue must exceed your fixed costs.
3. Product value
Another factor that has a say in your selling price is your customers’ expectations. Put simply, it’s their willingness to spend money on your product or service. Conduct a survey to find out what drives value for your customers and whether they see value in your product offering. This is what you should ask your audience:
- What do they think of your product costing X? Is it cheap, affordable, or expensive?
- If they could purchase your product for any amount, how much would they be willing to pay?
Your competitors’ pricing is also important. Do a market research and find out how much other businesses in your niche charge for similar products. When setting a product’s selling price, companies tend to use one of the three common pricing strategies:
- Average market price. This pricing technique is the best way to minimize risks. On the flip side, it takes away the opportunity to differentiate your product based on price.
- Price above the market average. If you aim for prices that are higher than average, you must back up your pricing policy and build a strong positioning strategy.
- Price below the market average. Damping is an effective way to separate your product from the competition and lure in customers. If your business can afford to sell at lower prices and still remain profitable, good for you. It might be a good strategy for a market newcomer.
Time is a fundamental factor which is, oddly enough, often overlooked by budding entrepreneurs. Your product price must include the time you invest into growing your business. Think about how much time you spend negotiating with contractors and partners, promoting your brand on social media, devising a positioning strategy, etc. Here are a few tips to keep in mind:
- Track how much time you spend on each task — even if it’s a trifle.
- Price one hour of your work and incorporate this value into your product price.
- Save time by optimizing your business processes. There are a ton of ways to do that. For example, you can delegate minor tasks to your teammates instead of doing everything yourself. Also, use a smart and fast online service (e.g., Logaster) to craft a professional brand identity for your business — especially if graphic design is not your forte.
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Two common methods to price your product
There is no lack of methods for calculating the optimal product price. Let’s focus on two basic pricing techniques which are ideal for beginning business owners.
1. Cost-plus pricing
When using cost-plus pricing, you need to add the desired profit margin to your break-even point.
For example, let’s say that you’re producing home-made fabrics. Your costs per product unit are as follows: materials — 10 USD; labor — 10 USD. Your desired profit margin is 40%. Your selling price is calculated like this: (10+10) х 140% = 28 USD. Your profit for each unit sold will be 8 USD.
This method works best when your expenses are more or less constant. If your materials costs are fluctuating due to, say, volatile market situation, you should better use another pricing technique.
2. Target pricing
Target pricing is the polar opposite of the cost-plus technique. When applying this technique, you need to identify the average market price and subtract your desired profit from it. The resulting value will be the target cost for your product.
Let’s go back to the example with the home-made fabrics. Say, the competitive price for custom pillow cases in your niche is 30 USD. Your desired profit margin sits at 10 USD per unit. This means that you must manufacture your product at 20 USD — or below this limit. If you spend more, you’ll get less profit.
A good thing about target pricing is that it helps you minimize costs. However, if you aim for the highest quality of your products, you might not appreciate this price calculation method.
When should I adjust my pricing?
Whatever price you decide on, you need to constantly adjust it. Your price must be dynamic and move with the market, ensuring the optimal balance between your profits and customer satisfaction.
When you should raise your price:
- You started with the price below the market average to draw in customers.
- Your business generates no profits or less profits than you originally thought.
- Your product is selling at a high volume.
- Your variable and/or fixed costs have increased.
- You’re scaling up your business by diversifying your product line, taking on more staff, or expanding your production capacities.
When you should lower your price:
- Your product is not selling well.
- You’ve optimized business processes and trimmed manufacturing costs.
- There is a risk that your customers might leave to your competitors with better prices.
Decreasing — and especially increasing — your price is a serious decision which should not be taken lightly. We’ve put together a checklist of what you need to do before adjusting your selling price.
- Keep an eye on the market. Take the time to analyze the market situation, including your competitors’ behavior, new product releases, demand dynamics, etc.
- Make a projection of how a change in price will affect your sales, market position, etc. By making a hasty decision, you risk missing out on profits.
- Decide by how much you wish to adjust your price. Watch out when raising your price. Instead of increasing your price all at once, consider doing that in several increments to let your audience adjust to the change. Offer a perk to your customers so that they don’t feel robbed. For example, it might be a good idea to launch a loyalty program or seasonal promotions.
- Talk to your audience and address the price change. It’s a great opportunity to draw attention to your brand, showcase your product’s advantages, and nurture a bond with your customer base.
- Choose the best timing. The best time to raise your selling price is at peak demand, before major holidays, or in high season.
Clever pricing is the cornerstone of a strong, sustainable business. Determining the optimal selling price for your product is not rocket science. There is nothing you can’t wrap your head around! You need to calculate your variable and fixed costs, consider your competitors’ prices, and take into account your time investments. Also, make sure your price fits your product value. Although increasing your selling price can be tricky, it’s an integral part of your business development. Be open with your customers about a price surge and offer them a perk to offset the unpleasant news. It can be a loyalty program, free shipping, and whatnot.