A small business guide to product pricing

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I want to tell you a story, about three cupcake stores…

Kara’s Kupcakes sold delicious cupcakes and was known for being the
most affordable cupcake store in town. Amidst the perpetual line snaking
out of her store, Kara operated her business efficiently—but she
recently discovered a problem. Despite selling out of cupcakes daily,
she was barely making enough profit to cover her expenses.

Some of her more candid customers would tell her they couldn’t
believe that she charged so little. Kara knew she wasn’t charging enough
to cover the time and energy it spent to make the cupcakes, but she
didn’t feel right about disappointing her customers and charging more to
make a profit.

Sensing an opportunity, Kara’s friend Chris later opened a high-end
cupcake shop a across town, charging far more than Kara. Chris’s
customers kept coming back because they knew his cupcakes were worth
every dollar—each one had surprising and delightful ingredients. After a
few months, Kara started to notice less foot traffic coming into her
store—it turned out Chris was poaching some of her customers with the
premium experience his shop offered.

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But all was not right at Chris’ cupcake shop. Many potential
customers entering the shop walked out after one glance at the price
tags. Chris was disappointed that he’d often make cupcakes that didn’t
get sold at the high price (it also hurt to throw them out), but he felt
trapped—his costs were too high to slash his retail pricing.

Then, to both Chris and Kara’s surprise, their mutual friend Paulette
started Paulette’s Pastries a few months after Chris opened his
high-end cupcake shop. After hearing about both of their struggles with
pricing, Paulette felt she could thread the needle between price and
cupcake quality.

From the outset, Paulette carefully forecasted, tracked, and
calculated her costs to make the cupcakes and added a fair profit margin
to the costs to find a price that people were willing to pay. Her line
was never as long as Kara’s, but regularly sold her cupcakes by the
dozens, and kept doing so as her reputation spread.

Pricing your products can be very psychological, and a little like a
Goldilocks experience: charge too much and you don’t attract enough
customers. Charge too little, and you create demand, but you may not be
able to cover your expenses.

Finding the perfect retail pricing strategy
is a delicate balance, but it’s well worth the time to do some pricing
analysis to find the best pricing levels for your company.

Price versus value

There’s a fine line between what you charge customers and the value
they perceive that product to have. In the cupcake example at the start
of this article, we saw that customers thought Kara’s Kupcakes provided a
stellar value for the price, but that Chris’ Cakes weren’t worth what
they cost to buy.

The key to pricing is to make customers feel like they’re getting
tremendous value without cutting into your profit margins. That
perceived value—the worth a customer assigns to your product—doesn’t
have to come from you offering the lowest prices; you can create value
by offering add-ons (unlimited phone calls if a customer has questions, a
free report or assessment, a surprise gift bag, free aromatherapy with a
massage, exclusive access to content) and still charge a fair price.

But how do you determine that fair price—the amount customers are
willing to pay for your products or services? The truth is, it usually
takes some trial and error to get it right. We’ll dive into three
pricing strategies to make things easier in a moment, but one thing to
note…

As a general rule, it’s better to start by charging too much and then
reducing your pricing levels if you’re turning off customers with a
high price point. If your prices have been low and you’re not covering
increasing costs as easily, it may be time to raise them. It’s a tricky
task, but one that you can take inspiration from Netflix on: the brand recently increased its monthly subscription by $1 or $2
(depending on the plan), and customers haven’t balked much. Why?
Because the value that Netflix offers is in line with the small increase
in price. If you’re going to raise prices, make sure there’s value
coming along for the ride for your customers.

First, do more homework

Before you can determine what a fair price is for a retail product,
you need to understand what the market will bear. Do a pricing analysis
to see what they charge for similar products, and how frequently they
change the price (e.g., through promotional discounts). While you
certainly don’t want to go far out of range with your own pricing
strategy, you don’t necessarily need to offer the lowest price. You just
want to get a sense of where pricing falls in your industry.

Next, you need to dig into all of your true product costs.
Many new businesses only focus on materials and labor and don’t factor
in costs like brand, overhead, and salaries. Every expense that goes
into running your business needs to be accounted for when trying to
determine pricing.

And finally, research average profit margins in your industry. The
field you work in will determine profit potential: a financial services
business might see profits of 26% on average, while a restaurant might
see 10% or less. Knowing the average, starting with a quick market
survey or Google search, and diving in by asking former business owners
or non-competitive operators can help you get an idea of the profit
margin you want to build into prices.

Now we’ll look at three ways you can price a product:

  • Dynamic: based on demand and perceived value
  • Competitive: based on the comparative value in the marketplace
  • Cost-Plus: based on margins and volume

Dynamic pricing: all about supply and demand

Rather than having a constant price, a dynamic pricing strategy
adjusts prices for products in real-time based on supply and demand.
Consider how utility companies charge more for electricity used during
peak use hours. Ecommerce brands like Amazon also leverage dynamic
pricing based on demand for certain products. Though not a retail
example, the most infamous and controversial example of dynamic pricing
might be Uber’s surge pricing.

Dynamic pricing operates off of perceived value
(the worth a customer assigns to your product) and not inherent value
(what a product is worth based on expenses incurred), thereby letting
the demand of an item determine the price. On a cold winter’s evening,
you probably want to jack the heat up to stay cozy in your house. What
you pay to use the heater during peak hours is worth it to not have blue
fingers and chattering teeth.

Benefits to dynamic pricing strategies

You have greater flexibility over your pricing strategy when you
apply dynamic pricing to your products. If a product is in demand, you
can charge more for it and see higher profit margins. If you’re
struggling to sell it, you can reduce the price while still earning
enough revenue to remain profitable.

You can also take business away from the competition if your price
adapts to lower demand. Once people have purchased from your brand at a
low price, you’re aiming for them to pay more for other products down
the road.

This might sound complicated, but it’s a cinch with the right business management software. For example, you can set pricing rules
to change prices based on certain conditions rather than manually
changing them. Having control over your pricing and maximizing your
profit margins is easy with dynamic pricing.

Examples of dynamic pricing

There are several different techniques within this pricing strategy:

Price discrimination: A brand sells the same
products at different prices. These may be sold to the same consumers or
different ones, through one sales channel or many. An example is a
retailer who sells athletic apparel on its website at full price and
lowers its prices on Amazon to meet that audience’s expectations.

Price skimming: With this technique, pricing starts high to attract early adopters
and consumers who aren’t price-conscious, then gradually lowers over
time. Useful for software or technology companies seeking to communicate
high value for new products. Apple is well-known for charging top
dollar for its latest iPhone and then reducing the price over time.

Yield management: For perishable or time-sensitive
products (think hotel rooms or airline seats), pricing is adjusted
accordingly to maximize sales. Getting a lower profit margin is better
than making no money on a product.

Competitive pricing: stand out in the marketplace

If you know what your competitors are charging for similar products,
you can match them in the hopes of gaining market share by offering more
value to accompany the pricing.

An example of competitive pricing happens every week in your Sunday
paper. You’ll see multiple drug store brands’ ads selling essentially
the same products for around the same price. One might offer triple
loyalty rewards with a purchase, or a coupon for the next visit.

Benefits to competitive pricing strategies

When you know what the competition is charging, it makes it easier for you to find ways to stand out with your own pricing model.
Whether you opt to beat their prices or offer more value to charge
more, you know your market and can deliberately choose how to price your
business:

Examples of competitive pricing

There are several pricing strategies you can employ with competitive pricing:

Penetration pricing: For new products in the
marketplace, charging a low introductory price gets customers into the
habit of buying. After that, a brand can slowly increase pricing. When
food brands introduce a new product (cereal is a great example), they
offer it at a low rate initially. Once people have tried the cereal, the
price goes up…because now they enjoy and trust it, they are more likely
to keep buying it at the higher price.

Promotional pricing: Similar to penetration pricing,
this strategy offers a product at a reduced rate temporarily. For
example, Macy’s typically charges higher prices than its competitors for
its clothing, but often has limited-time discounts or coupons that make
their clothing more affordable. Our imaginary business owner from the
opening section, Chris, could use this model to get more customers into
his store to taste his cupcakes for the first time.

Captive pricing: Pricing for the main product (like a
razor) is low, but the accessories or add-on products are higher-priced
(razor blades). Because people need the accessory, a business gets
built-in high, recurring, profits.

Bundle pricing: Offering more than one product as
part of a package deal, the shopper pays less for each item when buying
them together. A shampoo might be bundled with a conditioner, the total
price costing less than the two individually.

Cost-plus pricing: profit margin + cost

One of the simplest of the pricing strategies is cost-plus pricing.
Once you determine the cost of your product (as well as all those other
expenses mentioned at the start of this article), and your target
profit margin, add these numbers up to determine your price point. If a
coffee maker costs you $15 to make, including all costs, and you want a
20% profit margin, you would charge customers $18.

Leaping back to our opening example, Kara could use cost-plus pricing
to move her prices up a little bit. Otherwise, she’d have to figure out
a more sophisticated captive or bundle pricing model, lower her costs,
or go out of business.

If, however, you plan to sell volume amounts to distribution channels
like retail and e-commerce, you would need to reduce your per-unit price
to reflect wholesale pricing.

Examples of cost-plus pricing

Here are a few examples of cost-plus pricing strategies:

Variable cost-plus pricing: Sometimes costs aren’t
fixed, and that needs to be accounted for. If it’s cheaper on a per-unit
basis for you to manufacture 10,000 products versus 1,000, you can
charge less for larger orders. A candle brand that sells on its own
website would drop the price per candle to supply a conference hall with
100,000 candles, and the candle brand’s cost would go down since larger
quantities of supplies would cost less per unit.

Tiered pricing: By offering different packages with different levels of services or products, a brand can charge more for each level. An example is a software subscription with Basic, Advanced, and Enterprise packages, each with more features.

Final thoughts

Developing your pricing model
can take time, and it requires keeping a pulse on your audience’s
ever-changing preferences. Are they more likely to buy based on price,
or do they prioritize value above all, and are willing to pay a premium
for your products?

Know that discounting your pricing might be a good promotional
strategy temporarily to attract new business, but ultimately it will cut
into your ability to invest in the future of your business.

Had Kara been a bit more flexible in charging what her cupcakes were
worth (calculating her costs, then adding a profit margin), she might
still be in business. And if Chris had worked to find more affordable
ingredients to bring down his price, more customers might be gobbling up
those cereal milk cakes. Paulette’s business, driven by the market, was
pragmatic — and enabled her business to endure.

Settling on a pricing solution doesn’t have to be carved in stone. You can raise your prices,
but do so mindfully. Only raise them if you’re not covering your
expenses (or if your expenses have recently increased), or
infrequently—every few years. Let customers know in advance that your
prices will increase so it’s not a nasty surprise.

Finding that perfect price point for each product ensures that you
have a healthy profit margin that will help your business thrive over
time.

Want to boost your business sales funnel? Check out our handy guide to sales funnel basics

https://quickbooks.intuit.com/payments/ecommerce/#how-to

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This article originally appeared on QuickBooks Resource Center and was syndicated by MediaFeed.org.

Featured Image Credit: iStock.

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