How to calculate the ideal selling price for your product? What factors to consider? When to raise prices? These crucial questions pose a real challenge for budding entrepreneurs. However, this choice doesn’t have to be intimidating. This article provides a roadmap for pricing your product. Come on!
5 factors that affect the price of a product
The price of a product is determined by a multitude of factors that can vary depending on your industry and the specifics of your business. We’ve identified 5 key factors to consider when setting the retail price for your product.
1. Variable costs
Variable costs refer to the amount of money needed to manufacture and/or distribute a unit of your product or service.
- For Manufacturers: Calculate how much it costs to produce one unit of your product. Consider the cost of materials, tools, manufacturing, packaging, shipping, and marketing.
- For resellers: Calculate purchase and shipping costs.
- For service providers: Estimate the perceived value of your service and determine your hourly rate.
These costs generate the minimum price you need to charge for a unit of the product to close the accounts in the blue.
2. Fixed costs
Fixed costs have nothing to do with the manufacturing process, the number of units produced, or the market situation. Fixed costs include rent payments, utility payments, taxes, your staff salary, loan payments, etc. Remember that your sales revenue must exceed your fixed costs.
3. Product Value
Another factor that directly influences your sales price is your customers’ expectations. Simply put, it’s your customers’ willingness to spend money on your product or service. Do some research to find out what creates value for your customers and whether they see value in your product offering. Ask the following questions:
- What do they think of your product for X cost? Is it cheap, affordable, or expensive?
- If they could buy your product at any price, how much would they be willing to pay?
The prices of your competitors are also an important factor. Do market research and find out how much other companies in your niche charge for similar products. When setting the retail price for a product, companies tend to use one of three common pricing strategies:
- Average market price. This technique is the best way to minimize the risks. On the other hand, this makes it impossible for you to differentiate your product based on price.
- Price above the market average. If you aim for above-average prices, you should study your pricing policy very well and build a strong positioning strategy.
- Price below market average. It is an effective way to separate your product from the competition and attract your customers. If your business can afford to sell products at lower prices and remain profitable, good for you. It can be a good strategy for someone just starting out.
Time is a key factor often overlooked by developing entrepreneurs. The price of your product should include the time you invest in growing your business. Think about how much time you spend negotiating with contractors and partners, promoting your brand on social media, developing a positioning strategy, etc. Some tips to keep in mind:
- Know how much time you spend on each task, no matter how little.
- Find out how much an hour of your work is worth and incorporate that value into the price of your product.
- Save time by optimizing your business. There are many ways to do this. For example, you can delegate smaller tasks to your teammates instead of doing everything yourself. Also, use a fast, online service (e.g. Shopify) to create a professional brand identity for your business – especially if graphic design isn’t your forte.
Two common methods for pricing your product
There is no shortage of methods to calculate the price of your product. Let’s focus on two basic techniques that are ideal for start-up business owners.
1. Cost-plus pricing
When using cost-plus pricing, you need to add the desired profit margin to your breakeven point.
For example, let’s say you produce homemade fabrics. Its costs per unit are as follows: materials — R$ 10; labor — R$10. Your desired profit margin is 40%. Your selling price should be calculated like this: (10+10) х 140% = R$28. Your profit for each unit sold will be R$8.
This method works best when your expenses are relatively constant. If material costs vary greatly because the market is volatile, for example, you should 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 the desired profit from it. The resulting value will be the target cost of your product.
Let’s go back to the example of homemade fabrics. Let’s say the competitive price for custom pillowcases in your niche is $30. Your target profit margin is $10 per unit. That means you must make your product at R$20 — or below that limit. If you spend more, you will earn less.
The great thing about target pricing is that you can minimize your costs. However, if you want your products to be of higher quality than average, we do not recommend this calculation.
When should I adjust my prices?
No matter what your price, readjustments always occur. Your pricing must be dynamic and move along with the market, ensuring the ideal balance between your profits and your customers’ satisfaction.
When should you raise your price:
- You started with a price below the market average to attract customers.
- Your business does not generate profit or generates less profit than you had imagined.
- Your product is selling at a high volume.
- Your variable and/or fixed costs have increased.
- You are growing your business, diversifying your product line, hiring more employees, or expanding your production capabilities.
When should you lower your price:
- Your product is not selling well.
- You have optimized your business processes and reduced manufacturing costs.
- There is a risk that your customers may switch from you to your competitors who have better prices.
Lowering — and especially raising — your price is a serious decision that should not be made without a detailed analysis of the situation. We’ve made a list of everything you need to do before you adjust your selling price.
- Keep an eye on the market. Spend time analyzing the market situation, including the behavior of your competitors, new product launches, 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 losing profits.
- Decide how much you will raise. Be careful when raising your price. Rather than raising your price all at once, consider doing this gradually so your audience adjusts to the change. Offer your customers perks so they don’t feel ripped off. For example, it might be a good idea to launch a loyalty program or seasonal promotions.
- Talk to your audience and quote the price change. It’s a great opportunity to draw attention to your brand, showcase your product’s advantages, and build a bond with your customer base.
- Choose the best time. The best time to increase your selling price is in peak demand, before the big holidays or peak season.
Smart pricing is the cornerstone of a strong and sustainable business. Determining the ideal selling price for your product is not an exact science. There is nothing you cannot learn. You need to calculate your variable and fixed costs, consider your competitors’ prices, and take into account the time invested. Also, be sure to adapt your pricing to the value of your product. While raising your selling price can be tricky, it’s an integral part of growing your business. Be upfront with your customers about the price increase and offer perks to make up for the bad news. It could be a loyalty program, free shipping, or something like that.