How to Price Your Products and Services
Pricing your products correctly is integral to the success of your business. That’s one big reason why business owners and entrepreneurs often approach the task with hesitation. While deciding on a pricing strategy may seem more complicated compared to other parts of running a business, there are concrete steps you can take to ensure your product price is appealing to your customers and conducive to your business growth. This comprehensive guide will help you understand what factors to consider when creating or adjusting your product prices.
The importance of pricing
The importance of the role pricing plays in your business success cannot be overstated. The goal of every business owner is to make money. Adopting the right pricing strategy can be the difference between breaking even, making a profit, and exponentially growing your business. On the other hand, an uninformed decision about pricing can have negative consequences on the performance of your product portfolio. Two potential outcomes of setting the wrong price for your product are under and overpricing.
Underpricing your product
Pricing your products at a cost that is too low is dangerous for the profitability of your business. Many businesses keep their prices low in hopes of increasing revenue through sales volume. However, with an underpriced product, it can be difficult to sustain sales volumes, even if your business plan includes an aggressive growth strategy.
In addition, studies show that pricing your product too low can result in a perception of lower quality, a consumer sentiment that can be difficult to shift once it takes root.
Overpricing your product
On the other hand, setting a product price that is too high is also tricky since consumers are always conducting their own research as they shop—and comparing what they find. Roughly 88 per cent of consumers pre-research items online before they buy.
Overpricing happens most frequently when a business first opens, because the primary decision-maker may be overcompensating for initial overhead costs, salaries, and other expenditures in the product price. However, overpricing can backfire in the long run as customers are likely to turn to more affordable alternatives for repeat purchases.
Consumers do research just like you, which is why a fair price is the most sustainable way to keep them coming back. To sell your product at a fair price, it’s essential to conduct research that helps you understand the activities of your competitors, your target audience’s expectations, and where your own product fits in this landscape.
Understanding business priorities for the purpose of pricing
To prevent over and underpricing your products, it’s a good idea to step back and establish your business priorities. Taking stock of your unique situation and using this knowledge can help inform your pricing strategy.
While every business wants to maximize profits, your specific business goals may include breaking into the market with a penetration strategy, increasing the market share of your product, or decreasing costs. Other factors to consider having in your pricing strategy are industry trends, the life stage of your business, and offsetting research and development costs. A market penetration strategy may involve a lower introductory price while offsetting research development costs would increase your product price.
The combination of these factors is unique for each business and should be assessed on a case-by-case basis.
3 ways to conduct product pricing market research
Chances are, your business already conducts some type of market research as part of its annual financial assessments. Market research doesn’t always take the shape of a report, a survey, or cold calls. While these are often associated with market research, it can be as simple and personal as a conversation with your customers at the checkout counter. The three primary areas of market research that inform pricing strategies are the target, costs, and competition.
1. Target audience
The first area where market research may occur is around the business’ target audience. A target audience means a group of existing and potential customers who have a need or want of your product. A target audience can be general and demographically informed, such as “men aged 40+” or granular as “eco-conscious Millennial moms in the greater Toronto area.” You can learn more about helping you identify and target your audience online through social media platforms like Instagram and Facebook to help your products connect with the right audience.
The second area where market research may occur is around product-related costs. It’s essential for every business owner to understand the expenditures that go into a product. Product costs may include fixed costs like storage and retail space rental fees and flexible costs, like shipping and packaging. Understanding product costs can help owners get a sense of the real cost of a product and the efforts and processes involved in bringing it to market before assigning a price to it.
The third area where market research may occur is around the competition. You can use your competitors’ prices to help create a benchmark for customer expectations. Then, you can use what you know about your product costs and the target audience to identify an edge your product can offer over the competition. Blindly matching competitor prices may hurt you long term as it doesn’t factor in the value your business brings to the table, like additional services or a more premium brand perception.
Running a successful business means knowing where you and keeping a pulse on industry shifts, and regularly conducting market research can help you stay ahead of the curve.
Popular pricing strategies
There are many different pricing strategies employed by businesses. Even the same business may use different pricing strategies for products. For example, sellers on Etsy set their own product prices and promotional offers employing a variety of pricing strategies.
Understanding the differences between pricing strategies can help you identify the right one for your product. The three most common pricing strategies are cost-based pricing, competitive pricing and demand-based pricing.
Cost-based pricing is a strategy where the final price is determined by the product markup, which the seller decides. For example, an independent grocer may choose to sell produce at a markup of 35 per cent while cleaning supplies at 40 per cent of the cost price (the price that the seller pays to the supplier). The drawback of this strategy is that it is not informed by competitor activities. This can discourage consumers, who may feel that the prices are out of touch with what they perceive to be a normal price range for a specific product.
Another pricing strategy is competitive pricing. As the name suggests, this pricing strategy is informed by competitor pricing. Being aware of competitor prices can be a powerful tool. When you are aware of other pricing options your customers have, you can match, undercut, or charge more than the competition.
While it’s a good idea to keep a finger on the pulse of your competitors’ pricing on similar products, being too reactive can be a detriment for small businesses. It also means that your business will be held to high customers expectations of a quality experience for the same low price, making you work harder for a lower profit.
A third commonly used pricing strategy is demand-based pricing, which is called an elastic pricing strategy because it is mostly leveraged when a business responds to market forces. Businesses like Uber leverage demand-based pricing when demand for a service in a certain area increases, leading to surge pricing.
Similarly, a business that may find the demand for a product waning will use demand-based pricing to lower the price and encourage purchase. A decrease in product demand can lead to discount sales, which is a promotional tactic used as part of a demand-based pricing strategy.
It’s important to note that your own business’ pricing strategy can vary between products, projects, and even clients. The best way to find the right strategy for your business is to combine market research with your own business’ set of circumstances and business priorities.
Arriving at a value-based price
For specialized businesses like niche merchandisers and specialized services, value-based pricing can help offer the optimal value of the business. A value-based price is one where the perceived value of the product or service correlates to its fit in terms of the needs and wants of the customer. With this approach, a product only has monetary value if the customer deems it to have value. Customers add value to a product by purchasing, creating a system of supply and demand that businesses can benefit from.
A company can leverage value-based price for its products when it puts customers at the core of its decisions by offering:
- A better price in the consumer’s point of view
- Additional resources and services that help you add revenue streams to your business
- A product that delivers value that matches the needs or wants of the customer
Ultimately, the right pricing strategy is the one you identify for your business based on your business goals and the opportunities identified in your market research efforts.
Monitoring market reaction to set prices
Once you decide to apply a specific pricing strategy to your product, it’s important to be diligent about tracking its success within your product portfolio. Generally speaking, price adjustments are closely tied to consumer behaviour. If the price you set is too high, you’ll see a sharp dropoff in sales shortly after the price is set. If you set the price too low, you may find the product to be selling faster than you can keep up with demand. It’s important to be monitoring product sales performance on a monthly basis in order to give you time to react and optimize opportunities for your products.
It’s always a good practice to be continuously testing pricing offers for their target audience so that you know how your audience reacts to price elasticity. Promotions can help measure how receptive your customers are to price discounts and premiums.
For example, over time, you may find that adding incentive programs and rewards may offset a price increase for your product. Before making a permanent price change, it’s good to have a grasp of how your customers are likely to react to it, and continuously testing your pricing can help you anticipate how the change in price is likely to affect your sales forecasts.
Knowing when to lower or raise your prices
Product pricing is not a set-it-and-forget-it part of running a business. In fact, quite the opposite. While decisions to raise or lower product price should be done with intent after extended research analysis, most business owners need to adjust their product price multiple times in the lifespan of their business. Some factors that can contribute to a reassessment of product price include:
- New market players and their respective pricing models
- Research and innovation breakthroughs in the field
- Product trends leading to increases or decreases in demand
- Brand perception among consumers
As a result of these and other factors, product prices may require an adjustment to keep being profitable. When it happens, you may need to lower or raise your prices.
Raising your prices
Having to raise prices is an essential part of running a business. While the reasons behind it can be simple or complex, the answer to “Should I raise my prices?” lies in your ability to maintain an edge over the competition while meeting the profit margins you want your business to be making. You may need to increase prices along with the cost of production or to offset the cost of an investment like a storage or manufacturing facility. Lastly, you may consider raising your prices if you notice multiple competitors doing the same.
Lowering your prices
Some of the reasons you may need to lower your prices are dealing with a sales slump after raising them too high, or to make room for the price tag of a new innovative product entering the market.
Before considering permanently lowering your prices, you can leverage promotions that incentivize product purchases like a free complimentary product or service. Another alternative to lowering your prices is to “offer less bang for your buck” to customers, which can reduce your costs without drastically affecting the perception of product value your customer has.
Pricing your products and services is within reach
A successful approach to product pricing is grounded in a business’s priorities, informed by market research, and responsive to customer needs. Offering the right product at the right price is imperative to a business’ success, and continuously monitoring and adjusting your pricing strategy is essential to growing your business.
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This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.