How to price a product when starting a business
- Your pricing can be affected significantly based on where you plan to sell products
- Know your variable costs and fixed costs when deciding on pricing with outside vendors
- Customer personas keep you on track by reminding you of what your customers care about most
One of the trickiest parts of starting a new business is determining how to price your product. Product pricing is a delicate balance. If you set your product price too low, it can negatively affect your profit margin. But if you set a price that’s higher than what your competitors charge, you can lose out on sales.
Every small business owner should do market research before setting price points. While the cost of goods can seem like simple math, consumer behavior is more than just a numbers game—there are many other factors at play. Your pricing structure should consider human behavior as well as business costs.
With that in mind, this guide offers common pricing strategies on how to price a product for the maximum return. But before we talk numbers, let’s review some basics.
Questions to ask before pricing a product
Before picking out a price range for your new products (or changing the price on a product that already exists), it’s essential to answer these questions about your business:
- Where are you selling? Is it only at a physical location or do you also have an ecommerce business?
- Are you pricing a product or service?
- Who is your target customer base? Are you in luxury or budget segments? Or is it a mix of the two?
- What is the product cost to get your goods in the hands of customers?
- Who are your main competitors that sell similar products?
Once you establish where your small business fits in the broader marketplace, it can help you determine the right pricing model.
4 tips on how to price a product
When you determine the right product price, you set your small business up for success. It means you can sustain your business by making your customers happy and boosting your bottom line—here’s a step-by-step approach.
1. Invest in market research activities
Market research is how you gather information about your customers. It can include focus groups, surveys, social listening (i.e., monitoring what your customers say online), data analysis, and paying close attention to the competition—not just what they’re doing but also their results.
Excellent market research and branding allows you to achieve an ingrained familiarity with your audience. When your company name or product is mentioned, the goal is to create a positive feeling or association. You also want your brand to be the first thing someone thinks of when they think of your industry or offerings. For example, think of how many people refer to all facial tissue as Kleenex or all cotton swabs as Q-Tips. These brands are so familiar that their names are used more often than the generic item names.
Researching and listening to what your customers value most—and least—in your product can help you choose the right marketing strategy to reinforce brand loyalty. When customers are loyal to a brand, the price is much less of a factor.
2. Know where you’ll sell your products
Your pricing will be affected by fixed costs and variable costs that you incur from running your small business. Here’s a quick breakdown of what these terms mean:
Fixed costs: A fixed cost is any static expense you need to run your business. For example, your fixed costs might be your monthly lease payment, general liability insurance, Wi-Fi or internet, payroll for your employees (and yourself), government fees or licenses, and a monthly phone plan.
Variable costs: Variable costs fluctuate according to how well your business is doing. While fixed costs remain the same for the most part, variable costs can increase or decrease according to sales volume and production. Examples of variable costs include raw materials, labor costs, material costs, shipping costs, credit card or banking fees, and expenses for outside contractors or consultants.
To help gauge your variable costs, Freshbooks recommends the following formula:
Variable Costs = Total Quantity of Output x Variable Cost Per Unit of Output
For instance, let’s say you have a toy store and receive an order for 100 mini figurines for $300. To find the variable cost per unit, take the cost per unit in materials (50 cents) and direct labor costs (60 cents).
100 x (.50 + .60) = $110
In this case, your total variable costs would be $110, meaning the gross profit would be $190 ($300 – $110).
The physical location of a storefront also impacts how to price a product. For example, if you are paying top dollar for a monthly lease in a highly desirable area, your overhead may compel you to set a higher price point.
Before locking in the price of your product, you should take into account your location by calculating your fixed (rent) and variable costs (labor costs). Gathering pricing data on your top competitors in the neighborhood can also help you better understand the local market and inform your pricing strategy.
3. Create a customer persona
Knowing your customer is half the battle of your pricing strategy. If your target customer base is single women between the ages of 35-50 making over $100K annually, that could put you in the luxury category. As a result, you can afford to price products higher than say, the local Walgreens or Target.
The best way to know your customers is to design a persona. A customer persona represents your target customer base. It helps you identify their needs and problems, so you can effectively solve them. While you can base a customer persona on a real customer, it is essentially a fictional representation of who you aim to attract with your product.
Customer personas are helpful to:
- Remind you of who you serve and why
- Keep you focused on the goals of the customer rather than business goals alone
- Understand customer budgets
Think of a persona as your customer base vision board where you add inspirational quotes they live by, clippings from magazines about what they wear, brands they like, and challenges they face each day.
- Who is my customer? Consider age, location, income, and job title.
- What’s their lifestyle? Are they having frozen dinners every other night with their roommates or dining out regularly at the latest hot spots?
- What’s their biggest desire? Is it getting a haircut in a stylish, spa-like setting with other services such as manicures and facials? Or do they want an affordable, family-friendly hair salon where they can quickly get in and out?
- How does your product address the needs of your target customer? Do you offer on-call plumbing services outside of standard business hours?
When you understand who your customer is and how you can provide value to them, it will help you determine the right price for your product or service.
4. Monitor sales
Watching your volume in sales will help you evaluate whether you’ve set prices too high, too low, or just right. You can try different prices using sale prices and other research-based pricing strategies.
If your product is flying off the shelf and you’re struggling to meet customer demand, it might be time to consider a higher price. On the other hand, if your stock isn’t moving, it’s likely time to test out a sale price or lower the cost of your product. The important note here is to stay agile and be willing to experiment to secure the best market price.
Top pricing strategies for your product
These five common pricing strategies can help you effectively price your product. To figure out which strategy suits your target buyers, use the data gathered from the pricing tips above.
Grocery stores are famous for multiple pricing. For example: Buy two packs of yogurt and save a dollar, or buy three packs of yogurt and save $1.30. This pricing strategy works on most customers because it creates a higher perceived value. Costco has created an entire empire that promotes this idea of buying in bulk to save.
Giving customers an easy way to save builds loyalty and exposes them to more products and options that they may not have tried.
This pricing strategy refers to a markup that ensures a healthy profit.
The formula is:
Retail Price = [(Cost of item) ÷ (100 – markup percentage)] x 100
Let’s apply this equation to a pack of gum:
Retail price = [(1.25) ÷ (100 – 50)] x 100
The pack of gum costs $1.25. It is marked up by 50%, resulting in a retail price of $2.50.
A standard markup in retail is around 50%, but this formula can help you adapt based on your variable and fixed costs.
Competitive pricing is when you knowingly price your product below what your competitors charge. This type of pricing only works if you have a firm handle on your fixed costs and variable costs. Otherwise, it can negatively and quickly affect your profit margins.
This is when products are priced higher than what competitors charge to suggest prestige, exclusivity, and quality. This can work well if your customer base is in the luxury segment, but it can also price out potential customers who are more price sensitive.
This pricing strategy is when a company lists the original price next to the sale price to demonstrate potential savings. It’s a common sales tactic of online stores like Amazon that plays on customer’s psychological desire to get a deal.
You can use anchor pricing to sell products by placing them next to similar, more expensive items. This strategy stems from the idea that everyone loves a deal, and anchor pricing makes shoppers feel like they’re always getting one.
The right price for your product
As a small business owner, knowing how to price a product depends on several factors, including market research, where you’re selling your product or service, and who your target customer is.
One thing you can do to stay on top of market trends is to read and respond to customer reviews. You’ll learn quickly if they see the value of your product or service.
Yelp for Business makes it easy to see what your most passionate customers (and critics) say about you. That type of information you’d typically pay big bucks for in a focus group is available for free. It helps to know your customers well so that you can price your product competitively and keep them coming back.
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The information above is provided for educational and informational purposes only. It is not intended to be a substitute for professional advice and may not be suitable for your circumstances. Unless stated otherwise, references to third-party links, services, or products do not constitute endorsement by Yelp.