How to Price Your Products: Factors
to Consider
"There are many methods
available to determine the 'right' price," Willett says. "But
successful firms use a combination of tools and know that the key factor to consider
is always your customer first. The more you know about your customer, the
better you'll be able to provide what they value and the more you'll be able to
charge."
Know Your Customer
Undertaking some sort of market research is essential to getting to know your customer, Willett says. This type of research can range from informal surveys of your existing customer base that you send out in e-mail along with promotions to the more extensive and potentially expensive research projects undertaken by third party consulting firms. Market research firms can explore your market and segment your potential customers very granularly -- by demographics, by what they buy, by whether they are price sensitive, etc.. If you don't have a few thousand dollars to spend on market research, you might just look at consumers in terms of a few distinct groups -- the budget sensitive, the convenience centered, and those for whom status makes a difference. Then figure out which segment you're targeting and price accordingly.
Know Your Costs
A fundamental tenet of pricing is that you need to cover your costs and then factor in a profit. That means you have to know how much your product costs. You also have to understand how much you need to mark up the product and how many you need to sell to turn a profit. Remember that the cost of a product is more than the literal cost of the item; it also includes overhead costs. Overhead costs may include fixed costs like rent and variable costs like shipping or stocking fees. You must include these costs in your estimate of the real cost of your product.
"Come up with X first. X is your cost of raw materials, labor, rent, and everything it took to make the product so that if you sold it you would break even," advises Toftoy. "Y becomes what you think you need to make on it. That may depend on your business. Restaurants overall make about 4 percent, which is pretty low. If you want 10 percent then you factor that into your costs and that is what you charge."
Many businesses either don't factor in all their costs and under price or literally factor in all their costs and expect to make a profit with one product and therefore overcharge. A good rule of thumb is to make a spread sheet of all the costs you need to cover every month, which might include the following:
Know Your Customer
Undertaking some sort of market research is essential to getting to know your customer, Willett says. This type of research can range from informal surveys of your existing customer base that you send out in e-mail along with promotions to the more extensive and potentially expensive research projects undertaken by third party consulting firms. Market research firms can explore your market and segment your potential customers very granularly -- by demographics, by what they buy, by whether they are price sensitive, etc.. If you don't have a few thousand dollars to spend on market research, you might just look at consumers in terms of a few distinct groups -- the budget sensitive, the convenience centered, and those for whom status makes a difference. Then figure out which segment you're targeting and price accordingly.
Know Your Costs
A fundamental tenet of pricing is that you need to cover your costs and then factor in a profit. That means you have to know how much your product costs. You also have to understand how much you need to mark up the product and how many you need to sell to turn a profit. Remember that the cost of a product is more than the literal cost of the item; it also includes overhead costs. Overhead costs may include fixed costs like rent and variable costs like shipping or stocking fees. You must include these costs in your estimate of the real cost of your product.
"Come up with X first. X is your cost of raw materials, labor, rent, and everything it took to make the product so that if you sold it you would break even," advises Toftoy. "Y becomes what you think you need to make on it. That may depend on your business. Restaurants overall make about 4 percent, which is pretty low. If you want 10 percent then you factor that into your costs and that is what you charge."
Many businesses either don't factor in all their costs and under price or literally factor in all their costs and expect to make a profit with one product and therefore overcharge. A good rule of thumb is to make a spread sheet of all the costs you need to cover every month, which might include the following:
- Your actual product costs, including labor and the costs of marketing and selling those products.
- All of the operating expenses necessary to own and operate the business.
- The costs associated with borrowing money (debt service costs).
- Your salary as the owner and/or manager of the business.
- A return on the capital you and any other owners or shareholders have invested.
- Capital for future expansion and replacement of fixed assets as they age.
List the dollar amount for each on
your spreadsheet. The total should give you a good idea of the gross revenues
you will need to generate to ensure you cover all those costs.
Know Your Revenue Target
You should also have a revenue target for how much of a profit you want your business to make. Take that revenue target, factor in your costs for producing, marketing, and selling your product and you can come up with a price per product that you want to charge. If you only have one product, this is a simple process. Estimate the number of units of that product you expect to sell over the next year. Then divide your revenue target by the number of units you expect to sell and you have the price at which you need to sell your product in order to achieve your revenue and profit goals.
If you have a number of different products, you need to allocate your overall revenue target by each product. Then do the same calculation to arrive at the price at which you need to sell each product in order to achieve your financial goals.
Know Your Competition
It's also helpful to look at the competition -- after all, your customer most likely will, too. "Are the products offered comparable to yours? If so, you can use their pricing as an initial gauge," Willett suggests. "Then, look to see whether there is additional value in your product; do you, for example offer additional service with your product or is your good of perceived higher quality? If so, you may be able to support a higher price. Be cautious about regional differences and always consider your costs."
It may even be worthwhile to prepare a head-to-head comparison of the price of your product(s) to your competitor's product(s). The key here is to compare net prices, not just the list (or published) price. This information could come from phone calls, secret shopping, published data, etc. Make notes during this process about how your company and products -- and the competition -- are perceived by the market. Be brutally honest in your evaluation.
Know Where the Market Is Headed
Clearly you can't be a soothsayer, but you can keep track of outside factors that will impact the demand for your product in the future. These factors can range from something as simple as long-term weather patterns to laws that may impact future sales of your products. Also take into account your competitors and their actions. Will a competitor respond to your introduction of a new product on the market by engaging your business in a price war?
Know Your Revenue Target
You should also have a revenue target for how much of a profit you want your business to make. Take that revenue target, factor in your costs for producing, marketing, and selling your product and you can come up with a price per product that you want to charge. If you only have one product, this is a simple process. Estimate the number of units of that product you expect to sell over the next year. Then divide your revenue target by the number of units you expect to sell and you have the price at which you need to sell your product in order to achieve your revenue and profit goals.
If you have a number of different products, you need to allocate your overall revenue target by each product. Then do the same calculation to arrive at the price at which you need to sell each product in order to achieve your financial goals.
Know Your Competition
It's also helpful to look at the competition -- after all, your customer most likely will, too. "Are the products offered comparable to yours? If so, you can use their pricing as an initial gauge," Willett suggests. "Then, look to see whether there is additional value in your product; do you, for example offer additional service with your product or is your good of perceived higher quality? If so, you may be able to support a higher price. Be cautious about regional differences and always consider your costs."
It may even be worthwhile to prepare a head-to-head comparison of the price of your product(s) to your competitor's product(s). The key here is to compare net prices, not just the list (or published) price. This information could come from phone calls, secret shopping, published data, etc. Make notes during this process about how your company and products -- and the competition -- are perceived by the market. Be brutally honest in your evaluation.
Know Where the Market Is Headed
Clearly you can't be a soothsayer, but you can keep track of outside factors that will impact the demand for your product in the future. These factors can range from something as simple as long-term weather patterns to laws that may impact future sales of your products. Also take into account your competitors and their actions. Will a competitor respond to your introduction of a new product on the market by engaging your business in a price war?
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