How to Price Your Product or Service – Part 1

by smallbizbee · 2 comments

Pricing, the all important business decision that can make or break you. Determining how to price your products and services deserves more than a little bit of your attention, but the good news is it doesn't have to be as difficult as some will make it. In this two part series we'll talk through solutions to pricing a product and a service that will ensure you remain competitive and make an acceptable profit.

Pricing Your Products:

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There are three fundamental ways to price your products, and I advocate using a blend of all three when deciding on a final price.

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1. Cost Based Pricing

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Perhaps the simplest of all pricing structures, yet the one I would say leaves the most room for error because it looks primarily at internal factors when setting price. Essentially when using a cost based pricing model you add up all of your production or procurement cost associated with the product, averaged on a per product basis, and then add an acceptable percentage for profit.

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Example: You run "GetYourBikeOn.com" as successful online marketplace for low rider, beach cruising bicycles (pictured above). You have a supplier who you source your product through and can get the latest beach cruiser for $200 total cost, shipped to your customers door. Under the cost based pricing model you would take all of your cost of doing business, averaged over the number of bikes you sell in a given time period (let's say 30 bikes per month) then add profit for your troubles. If your business expenses are $1000 for the month ($33 per day) and each bike cost $200 you at least need to sell the bikes for $233 to break even. You may decide 10% is an acceptable profit so you would add $23 to that, and $256 becomes your target selling price.

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Flaws of Cost Based Pricing:

Does not take into account what the market is willing to pay
Does not take into account what your competitors are able to bring the same product to market for

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2. Competition Based Pricing

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Competition based pricing places emphasis on what your direct competitors are selling similar products for. Competition based pricing can be an extremely difficult pricing model if there is little to differentiate your product from your competitions. The less differentiation in products the more you will need to compete as a low cost provider in order to attract customers.

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Example: WalMart has decided to get into the low rider, beach cruising bicycle business, and uses the same supplier as GetYourBikeOn.com uses. They didn't negotiate very well with suppliers so they still get each bicycle for $200, but decide that they are willing to sell for only 1% profit on each unit. By pure coincidence WalMart's business expense for each bicycle sold is exactly the same as GetYourBikeOn.com ($33/bike), but because they are willing to accept less profit they can sell each bike for $235 or $21 cheaper than you.

See how hard it can be to compete purely based on what the competition is pricing their products for? Competition based pricing can still work, and what the competition is selling similar products for should factor into your analysis, but you will need to differentiate your product in order to be successful. In the example above maybe GetYourBikeOn.com can offer warranties, or free maintenance plans with their beach cruiser which would entice customers to pay a premium over what WalMart is charging.

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Flaws with Competition Based Pricing:

Heavily dependent on being the low cost provider if minimal product differentiation exist.
Does not factor in cost to produce or procure the product being sold.

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3. Customer Based Pricing

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Customer based pricing takes into account the buying habits, customer perception and sentiment for your product. Their cost to value perceptions will help you determine the proper price. This method allows you to differentiate your product based on quality and value, as well as charge a premium for perceived quality.

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Example: After some market research, and customer feedback to GetYourBikeOn.com, you find the #1 customer complaint regarding the new low rider, beach cruising bike you've started to offer is they break down a lot. So after careful research you find a supplier offering a beach cruiser with the highest quality rating in the beach cruiser industry. The bike cost you an additional $50, but you believe you can sell it to your target market for an additional $100 due to the high quality and customer satisfaction ratings it's received. Also, by being so in touch with the perceptions of quality within your customer base you can begin to take customers away from WalMart because you can point out they are selling an inferior product, and for a mere $100 more they can buy your beach cruiser and have a worry free biking experience.

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Flaws with Customer Based Pricing:

Customer sentiment, and the value exchange ratio, can change faster than the weather.
Still may not factor in your cost to produce or procure a product that meets the customer bases needs or whims.

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Product Pricing Solution

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So what's the product pricing solution? Use all three methods above when setting a price! None of the pricing models above should be used in a vacuum, and none are inherently "more right" than another.

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All product pricing conversations should start with the Cost Based Pricing model as that gives you a baseline, or bare minimum you need to sell your product for in order to stay in business. It also tells you if selling that product is even feasible for your company.

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Secondly a thorough examination of the competition and their price points for similar products should be taken into consideration. Work through the Competition Based Pricing model and ask yourself what is differentiating your product from theirs? Is yours totally unique, or exactly the same? Can you sell a similar product for less than your competitor, and still make an acceptable profit? Examining what you are bringing to market versus your competition will play a big role in guiding your pricing decisions. Remember, it is extremely hard to be the low cost provider so any way you can differentiate your product from similar products from the competition the more likely you will be to make an acceptable profit.

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Lastly, you need to use the Customer Based Pricing approach to ensure you are taking into account the perceptions of quality or value of your target market. What do your customers think of as important with regards to the product you're selling. What are they willing to pay, or how much more will they pay for better quality? =====

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Tying It All Together

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A product pricing structure with the best chance for success will tie in all the above when determining price. You will know what your bare minimum is you can sell your product for, you will be in touch with what similar products are selling for by your competition, and will have a good feel for where you can differentiate and meet the ever changing needs of your target market. From this information you can set a final price for the product and see if it meets the needs of your business for an acceptable profit. If it doesn't, you then repeat the process with any other product you want to bring to market, or rework your sourcing strategies, overhead cost structures, or product differentiation until you can sell your product for a price that meets the needs of your customers and your business.

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Stay tuned for part two in this series where we will examine how to price a service...

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