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We take a look at all the factors to consider when determining the price for a product.
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Pricing a new product is more of a complex task than it appears. In this article, we’ll discuss the factors to consider when determining how to price a product and outline some of the most effective pricing strategies available to sellers today.
If you need a simple way to calculate the selling price for a new product, you can use this formula: Add up all the costs associated with creating your product and bringing it to market, and then add your profit margin.
While this is a solid strategy to launch your product quickly, you’ll want to give more thorough consideration to your pricing strategy in order to maintain long-term profitability. Read on for a more detailed method of determining your pricing.
There are many factors to consider when choosing how to price a product, including production costs, market conditions, how much your target audience is willing to pay for the product, and how much your competitors are charging for similar products. It’s a lot to keep track of, but when designed correctly, your ideal pricing strategy will maximize both your profit and your revenue.
Below are four main steps to pricing your product.
No business or product exists within a vacuum, and so you’ll need to consider the state of your industry’s market when pricing a new product. For example, you may ask yourself whether the market you’re entering is emerging or well-established. Businesses introducing a new product into an emerging market often have more flexibility in setting a price, while businesses entering a more saturated market with several key competitors may need to be more conservative.
Other external factors that may determine how much you can reasonably charge for a product include:
Finally, your target audience will play a large role in how you price your product. Household income, age, gender, race, marital status, geographic location, and other demographics will likely factor into how much your audience is willing to pay for your product. Equally important to consider is your target audience’s psychographic information. Tapping into your audience’s pain points, and the problems they’re experiencing that your product can help to solve, will help you understand how to price your product.
One tried and true method of understanding your target audience is to create consumer personas. Download our free guide to find out how.
When determining how to price a product, you’ll want to take a close look at the prices your competitors have set for similar products. Generally, there are two different strategies you can take to help your audience choose your product over that of your competitors: you can price your product lower to make it more affordable, or you can add more value to your product to make it worth a higher cost.
When determining which path you’ll take, it’s often helpful to think about your brand’s unique positioning within your industry. If your brand is known for providing budget-friendly alternatives to your competition, you may risk alienating your audience by pricing your new product too high. On the other hand, positioning your brand as an innovative problem solver may allow you to set higher prices. Ask yourself: What needs does your target audience have that aren’t currently being met by your competitors? Is your product able to fill in those gaps? If your product can solve a problem no one else is addressing, your customers may be willing to pay more for it.
After considering your product within the context of your market and competitors, the next step in pricing your product is to choose a pricing strategy (we’ll outline a handful of common pricing strategies later in this article). The pricing strategy you choose will depend on multiple factors, including your product features, industry, business model, competitors, target audience, brand positioning, and revenue goals.
When reviewing the pricing strategies available to you as a seller, it’s important to note that you don’t need to limit yourself to just one—you can combine elements of a few different strategies to create one that best meets the needs of your business. Likewise, once you determine a strategy for pricing your product, you don’t need to be tied down to it forever. One strategy that works well for pricing a certain product may not work for every product you price in the future.
Pricing your product isn’t a one-time event, but rather an ongoing process. As your business evolves, as the economy fluctuates, and as you conduct research into your market and competitors, you’ll likely find that you need to adjust your pricing strategy. And while communicating price increases to your customers can be a point of friction, you can accomplish it in a considerate and transparent manner.
As long as the initial price you set for your products balances out your expenses and creates a profit, you’ll be able to fine-tune your pricing as you go.
Below is an overview of seven common strategies for pricing a product.
Also called markup pricing, cost-plus pricing is one of the most straightforward pricing strategies available to sellers. While other pricing strategies listed here take complex factors, such as brand positioning and audience perception, into account, cost-plus pricing only considers how much it costs your business to produce the product—your cost of goods sold (COGS).
To determine how to price a product using a cost-plus pricing strategy, start by determining how much it costs to make an individual product, and then add a fixed percentage based on how much profit you want to make. For example, if it costs your business $100 to make a product, and you wanted to make a $100 profit on each product sold, you’d set your product’s price at $200—a 100% markup.
While cost-plus pricing is simple, sellers who use it will want to be careful that they don’t set their markups too high. If your competitor is selling a nearly identical product that also costs $100 to make, and they’re only adding a 50% markup, your audience may be hard-pressed to choose your product over your competitor’s.
Premium pricing, also called luxury pricing, is a strategy where sellers set their product prices high to associate them with value and status. Unlike cost-plus pricing, premium pricing doesn’t focus on how much it costs to bring a product to market—instead, it hinges on the target audience’s perception of the product and its associated value. Premium pricing targets high-income demographics and is common among designer and luxury brands like Rolex, Tiffany, and Mercedes, who position their products not as commodities, but as status symbols—the best of the best.
While it can be enormously profitable, premium pricing is a long-game strategy that relies on masterful brand positioning. It can take years to build enough brand awareness and a strong enough reputation to convince your audience that your brand name alone is worth a luxury price tag.
Penetration pricing is a strategy where sellers introduce a product to the market at a very low price in an effort to draw attention—and business—away from competitors. It’s often used by new businesses looking to build their customer base by disrupting a crowded market. Penetration pricing isn’t meant to be used as a long-term strategy—such low prices wouldn’t create enough profit to keep a business running sustainably. Rather, businesses that use penetration pricing hope to draw customers away from competition with low prices, and then to provide a high enough value and a positive enough brand experience that those customers continue choosing their products even as their prices increase.
Penetration pricing is also used by businesses entering brand-new markets. For example, Netflix essentially established the streaming market in 2008 with their low-priced plan, providing an innovative product while positioning themselves as the original gold standard for that product. This name recognition has led to a high level of brand loyalty, with many customers sticking with the platform even as their prices have increased over time.
Skimming pricing is a strategy where sellers introduce a product to the market at an extremely high price, and gradually lower that price as demand decreases. This strategy is common for technology products that are in high demand when they’re first released but become less relevant over time as technology progresses or as updated versions of the product are developed. For example, Apple typically releases its newest iPhone model at a high price, then decreases the price over time as newer models come out.
Skimming pricing is particularly effective when demand is high, supply is low, and the product is innovative enough that competitors can’t mimic it. For instance, the PlayStation 5 was released in late 2020 to a market primed for skimming pricing: the console boasted advanced and inimitable features, demand for video game consoles was high due to continued pandemic lockdowns, and a global semiconductor shortage exacerbated an already limited supply. All this allowed PlayStation to set high prices for their new product.
Economy pricing is a strategy that allows sellers to set low prices but gain revenue through a high volume of sales. This pricing strategy is common in commodity-based industries such as groceries, drugs, and consumer packaged goods, where sales are driven mainly by necessity rather than by brand.
The success of an economy pricing strategy relies on the business’s ability to consistently sell high quantities of the product in question, meaning the product should be something a lot of consumers need on a regular basis.
Value-based pricing is similar to premium pricing in that it’s based off the target audience’s perception of how much a product is worth, rather than what it actually costs to produce it. But while premium pricing sets high prices in order to create the consumer perception of value, value-based pricing uses the consumer’s current perception of a product’s value to set its price.
A value-based pricing model allows businesses to set higher prices for products that their audience considers to be valuable, even if it the production costs for that product are low. However, using value-based pricing can also mean you’ll end up charging less for certain products if your audience doesn’t assign them high worth. For this reason, value-based pricing is typically most successful for businesses that offer highly unique and in-demand products—particularly those that enhance a consumer’s life experience or self-image—and is least successful for businesses that sell commodity products.
Companies that use a value-based pricing strategy conduct extensive market research into their target audience’s preferences and beliefs. They typically have strong branding and marketing strategies as well as a high level of rapport with their audience.
Ecommerce businesses could potentially use any of the pricing strategies described in this article. However, ecommerce models may have additional variable and fixed costs to factor into their pricing, including:
When determining how to price their products, ecommerce businesses should consider implementing smart pricing, or advanced pricing, into their strategy. Smart pricing is a functionality offered by some ecommerce platforms that allows sellers to create flexible prices for a product based on certain criteria. For instance, B2B ecommerce businesses might have custom pricing for different customers or accounts. Smart pricing gives your ecommerce business the flexibility to better serve your customers while remaining competitive in your industry.
As mentioned earlier, creating a strategy for how to price a product is an ongoing process, not a one-time decision. Even if a product is performing well, it’s typically a good idea to run an annual price analysis to ensure your price makes sense in the context of your competitors, your consumers, and the market at large. This will allow you to remain competitive as your business grows and scales.
Once you’ve assessed the health of your prices, you can assess the health of your website—use our free interactive tool to see how your store measures up.
Miva offers a flexible and adaptable ecommerce platform that evolves with businesses and allows them to drive sales, maximize average order value, cut overhead costs, and increase revenue. Miva has been helping businesses realize their ecommerce potential for over 20 years and empowering retail, wholesale, and direct-to-consumer sellers across all industries to transform their business through ecommerce.