Do you ever wonder how the prices of products are…
Do you ever wonder how the prices of products are determined? Why are some products more expensive than others, even when they fulfill similar functions with the same level of effectiveness? Businesses don’t price products whimsically. This article will help you understand the product pricing process and its importance.
Read on to begin.
What is Product Pricing?
Product pricing is a strategy that determines the value of a product to a consumer when they make a purchasing decision. Factors such as market characteristics, input costs, a company’s business model, product characteristics, and utility affect product price. The price of competing products can also affect product price.
The three main factors to consider are:
- The value you deliver to customers.
- Your brand’s position in the market.
- Competitor pricing strategies.
Why is it Important?
Product pricing is important because it dictates the growth margins of your business. Customers almost always avoid overpriced products, while companies may go bankrupt if they underprice their products.
The primary principle is to ensure customers get value from what they pay for, and companies profit from manufacturing and selling products.
Striking a balance between what customers are willing to pay for and company profits is key to pricing your products correctly.
The following section outlines the general process for determining a product’s price.
Key Product Pricing Steps
1. Summarize Variable Costs Per Product
This step means you must consider all costs related to producing your product. It can include raw materials, labor, and variable overhead costs (costs that change based on production volume).
Don’t forget that the time spent producing your product is also valuable; Include it in your cost summary.
A shoemaker spends $50 on raw materials. The shoe design is intricate and time-consuming. The shoemaker decides to add an extra $30 to account for time and labor costs. Therefore, each shoe will cost $80 to produce.
2. Set Profit Margins
Profit margins are the minimum amount of money a company needs to profit from a sale. The company’s profit margin is calculated by subtracting total costs from total revenues. You have to manage this budget line to have a successful business.
To earn a 25% profit, you need to price your product to cover variable product costs and make a 25% profit.
The shoemaker spends $80 to produce a pair of shoes. To earn a 25% profit, the shoemaker must sell the shoes for $100.
($80 covers production costs, and the shoemaker has a $20 profit.)
But that’s not all you need to account for.
3. Account for Fixed Costs
Fixed costs refer to expenses incurred regardless of production. Companies pay these costs even if they aren’t producing and selling a product.
These costs are built into the company’s operating costs. Whether you sell ten products or a hundred, you pay the exact price.
Fixed costs are challenging to determine. It’s why we highly recommend performing a break-even analysis. You may also use product price calculators to help make your job easier.
Bonus: Product Price Examples
Apart from your standard pricing process, you can also use these pricing strategies:
A competitor-based pricing strategy considers the prices your closest competitor charges. Your pricing can be derived by averaging the competitor’s price. Then, set your price higher or lower depending on your brand’s positioning.
Apple can charge a lot of money for its products. Apart from top-quality products, they also have excellent market positioning.
Cost-Plus pricing refers to the classic formula of selling price calculation.
Add your preferred pricing percentage to production costs for a single unit.
Our shoemaker wants a 25% profit. He adds 25% on top of production costs. As shown below:
$80 (production cost) + $20 (25% of $80) = $100 (Product price required to generate a 25% profit)
In value-based pricing, a product’s price is based on its value to the customer. (Plus production costs). Value-based pricing is most applicable to high-demand products.
It turns out that Cristóbal Balenciaga designed the pair of shoes. Designer brands are notoriously expensive because of their perceived value. Instead of charging just $100 (profit + production cost), the shoes now cost $400.
Identifying the factors important for increasing demand for your product is an important step in determining pricing. Price plays a vital role in the success of any business, but that’s not where product pricing ends. Understanding the three key steps above will help you sell products effectively without losing inventory.