It can be a daunting task to come up with pricing for your products. With 80% of consumers saying that pricing is the most important factor in purchasing decisions, how you price your products is nothing to be taken lightly.
Though pricing is an important part of operating a store, it shouldn’t be a debilitating concern that prevents you from moving forward.
In the world of commerce, pricing strategies exist that have proven to drive conversions while allowing business owners to focus more on product and less on price. The three most common pricing strategies are:
- Cost-based pricing
- Market-based pricing
- Consumer-based pricing.
While the decision is yours as to what ultimately works best for your business, having a solid grasp of tried and true methods will surely ease your burden and put you on the path towards success.
Cost Based Pricing
Cost based pricing is a strategy that is simple in theory, but can be time consuming up front; especially if you don’t already have a clear grasp of your true costs.
The basic tenant of cost based pricing is determining total product costs and adding on your desired margin. It is important to note here that “cost” doesn’t just mean COGS(Cost of Goods Sold). Cost refers to the total cost to produce a product, including employee salaries, storage fees, taxes, fixed costs and all other expenses that relate to putting a given product to market.
The basic equation for a cost-based pricing strategy is:
To translate that into plain English, say you make and sell soaps. Per one bar of soap you incur a:
- $.50 cost for materials
- $1.00 cost for labor and
- $.50 cost for manufacturing
- That leaves you with a total cost of $2.00.
If your desired margin is twice the cost of the product( a margin of 50%), then your cost-based pricing formula would look like this:
As you can see, there are several considerations that need to be made in order to complete the equation. The first of which is determining your costs. The second of which being a desired profit margin.
When it comes to profit margin, we often recommend starting with a 50% markup and adjusting accordingly based on store and customer data.. but more on that in a bit.
With a cost-based pricing strategy, you’ll be left with a price that you know works for your business.
While you may be thinking, “Shouldn’t I price according to what my customers will pay?”.. Yes, you should. As a business, however, the most important factor is arriving at a price that ensures a reasonable profit, which a cost-based pricing strategy inherently does.
Where it can be said that cost-based pricing is an “internal” pricing strategy, market-based pricing is almost exclusively external.
The key to market-based pricing is landing on a price that situates your product in an advantageous place in the market.
The first step in utilizing a market-based pricing strategy is researching how similar or identical products are priced. If your competition is selling a comparable product for, say $50, it doesn’t make sense to push for a higher price of $75. Concurrently, it may also be unwise to charge $30 when you’d likely sell a similar volume at a higher price.
When a product is competitive, the market does an effective job of determining a price point that makes sense for all parties involved. Attempting to be a price outlier is likely going to result in a decrease in profits for your business.
If you’ve recently purchased a new Apple computer, you may be asking yourself how Apple get’s away with selling products at a far higher price than their competition.
While attempting to act as a price outlier “typically” leads to lost profits, companies with established brands are often able to capitalize on their name and demand a higher price.
To better illustrate, let’s take a look at the shoe market. Reebok and Adidas Yeezy both sell sneakers that are comparable in many ways. If you’re familiar with the sneaker market, or are old enough to remember the 90’s and early 2000’s, you’ll know that the Reebok Workout is nearly identical to the Adidas Yeezy Powerphase.
Nearly identical with the exception of price.
A quick browse of Reebok.com shows that the Reebok Workout sneakers currently retail for $80. Compare that to the Yeezy Powerphase’s, which retail for $180 and you can clearly see the point.
The brand value that Adidas Yeezy holds, largely due to current cultural norms, allows them to sell a comparable product at a far greater price.
If you’re wondering how you can grow your brand and charge higher prices, get in line.
Joking of course!
In all seriousness, building a strong brand is something any business can do. Unfortunately, we don’t have time to cover that in depth in this post.
If you’re interested in learning more about building a brand and growing brand equity, we highly recommend checking out our material on branding, which can be found here.
Before we get too lost in the weeds, let’s get back to our main focus here. The point of a market-based pricing strategy is this:
Pricing your product in a way that puts it in an advantageous place in the market.
While it may be boring to conform to the masses, more often than not, your profits will be the highest when your products are priced at a pre-determined market price.
Consumer Based Pricing
Last but not least, we have the consumer-based pricing strategy. Much like the market-based pricing strategy, a consumer-based pricing strategy is largely external. Instead of focusing on the competition, however, the focus is directed towards your target customers.
The main benefit of a consumer-based pricing model is that your price is tailored to meet the needs of your customers. In order to develop an effective consumer-based strategy, you must first have a clear buyer persona.
In short, a buyer persona is:
a semi-fictional representation of your ideal customer based on market research and real data about your existing customers.
Knowing exactly WHO your target customer is extremely valuable to your entire business, even outside the world of pricing. If you’re interested in learning more about developing detailed buyer personas, we recommend checking out our ::buyer persona guide.::
With a clear vision of who your current and target customers are, prices can be adjusted to better meet their needs.
Say you sell a product that has been deemed environmentally friendly. In all likelihood, your target customer is someone who is environmentally conscious and typically purchases products that aligns with that lifestyle.
As it so happens, that consumer group on average is willing to spend more for a product that’s eco friendly than a cheaper alternative.
Knowing this about your customers allows you to price your product accordingly, even if comparable non-eco-friendly products are available at a fraction of the price.
The reverse of this is true as well. If you sell a product that has eco-friendly alternatives but is not eco-friendly itself, it doesn’t make sense to match the price of your eco-friendly competition. Your sales would likely be low, and your business would fail to make an adequate profit.
As you can see, having a clear view of your customer is extremely important in the success of your business.
Just because your product is comparable to another company’s doesn’t mean your buyer persona is as well.
Knowing the difference between the two and having a clear vision of the latter is a clear cut path towards lasting success.
To Wrap it all Up…
If you look closely at the three strategies we’ve discussed today, you’ll realize that pricing is as much of an art as it is a science.
What works for one company, may not work for another selling the same product.
It may seem like choosing the right price is an incredibly daunting task, but we assure you it’s not. As a best practice, spend a bit of time with each pricing strategy and determine what works best for you and your business.
If all else fails, go with one and adjust as time goes by. In all truth, no calculation is as valuable as real data. For the majority of successful businesses, a winning pricing strategy is hardly ever black and white.
Looking at the three pricing strategies we mentioned above shows you that there’s a valid case for utilizing parts of each.
At the end of the day, what works best is what works best. Use the data you have to determine an initial strategy, and make tweaks as time goes by.
If you follow that advise, we can almost but guarantee you’ll end up in a winning position.
And of course, if you’d like to discuss specific pricing strategies in more depth, feel free to reach out to our team to set up a FREE pricing consultation!