The recipe for success in business involves many ingredients. But perhaps none of them has as crucial a role to play as the pricing of your product or service. This is a decision that weighs heavily on the mind of any budding entrepreneur or small business owner – what is the right amount to settle at?
It is a tough ask because pricing can cut both ways; if your product is priced too low, it can eviscerate your competition, but at the cost of your profit. If you price is too high, meanwhile, you're receiving more revenue per unit, but you will not gain any traction in the market among your target customers.
As a result, there is a delicate balancing act involved in this process.
Pricing a Product
Of course, the price you set should ultimately be profitable for your business, while at the same time offering enough value to your customers.
Arriving at that point can be difficult, however. Given that it is a central aspect of business management, there are many approaches and strategies for pricing, but at its heart, it comes down to three core factors: cost, price and value.
The Difference Between Cost, Price, and Value
These three elements are highly interlinked, yet distinct aspects of the pricing equation. The cost of a product is generally considered to be the amount your business is forced to spend to create it. The price, on the other hand, is the reward you seek from your customer for providing the product or service.
These two figures can be calculated and laid out in exact numbers. If you spend X amount on product costs, then you should seek at least X+Y amount as the price from the customer, where Y is the reward your firm needs to sustain itself. It is quite clear that these two factors are embedded within your business.
However, the third factor – value – lies on the customer’s side (or, in many cases, the market environment) and cannot often be readily quantified. The value of a product is what the customer feels is the actual worth of the product in their lives. Value can be influenced by various factors, such as the intensity of the need, the availability of alternatives, and the pricing of similar products by competitors.
The key takeaway from these concepts is that a great pricing strategy requires information from internal and external sources. To illustrate this and provide some context, consider these four questions:
1. How Much Does the Product Cost?
The answer to this question is the basic minimum information that you will always need to decide a price for your product or service. It includes the cost of everything involved throughout the supply chain: raw materials, labour costs, transportation, warehousing, and any other overhead costs.
Once you have every relevant outgoing accounted for, you will be left with a clear idea of your product’s break-even point – the minimum price you should put on a product or service to ensure that you at least get back the money you invested in it. Prices that go above this threshold will create profit for your business.
An important thing to remember here is that in business, costs can vary depending on the quantity you produce. Since the output will fluctuate in business due to changes in demand and other factors, you will also have to factor in these fixed and variable costs.
2. What is Your Revenue Target?
Every business has its own profit and revenue goals, and the pricing of your product or service will have a significant impact on the chances of attaining these goals. Often, new businesses have very limited resources that must be juggled between production, marketing, payroll and more.
Therefore, you can only produce a finite quantity of products within a year. Use that number to divide the stated revenue target of your business for that year, and you will get the price at which you need to sell the product.
Revenue targets have to be tempered with realism. If you set the goals too high, you will have to set a high price on your products, which might end up being counter-productive in the marketplace.
3. How Well Do You Know Your Customers?
Any pricing strategy that does not adequately take into account the customer’s views is doomed to failure. It is as simple as that. Even if you know all about the cost-price balance required for profit, you still need to convince your customers of the value of your product or service.
To understand more about this value perception among your target customers, you will have to conduct some form of market outreach or research. This could be something as simple as surveys or questionnaires if you are a new business.
Try to get in-depth information about various demographics, including their buying patterns, price consciousness and sensitivity, among other things. Using this information, you can price your products strategically to target specific demographics with more significant impact.
4. How Much Do You Know About the Market?
For better or worse, business firms do not exist in a vacuum; the market is an arena, and there are other competitors, each with their own take on pricing.
Look for firms or brands that provide the same (or similar) product as your business in order to obtain some context. Find out the strengths and weaknesses of these rival products when compared to your own, and compare the prices of both. Do you have a product with more value, but which is priced lower? You may be able to set a higher price on it.
On the flip side, is your product inferior, yet overpriced when compared to your market rivals? If so, it may be time to consider a price adjustment or a product upgrade. You have to be brutally honest when making these comparisons.
Various other market factors need to be considered, too: seasons, festivals, and new technologies can all have an impact on the future pricing of your products or services. Therefore, market research is vital for pricing, as well as for many other aspects of a business.
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There is no shortcut to creating the right price for your product. As a business owner, you will need to factor in a lot of variables to arrive at a final calculation and even then, it does not remain final; pricing is a complex, ongoing activity.
The more information you have about the various internal and external factors involved, the better your chances of arriving at the right price for your needs. If you can answer all four of these questions with confidence, then your business is well on the way to a practical and profitable pricing strategy.
What do you think? Let us know your thoughts and opinions on pricing products in the comment section below.