Deciding how to price a product can mean the difference between success and failure for your small business. Price items too high and no one will buy, too low and you’ll struggle or even lose money. Pricing strategies are a mix of art and science, but the whole process can be streamlined into 3 primary factors covered here.
1. Understand the Basic Terms & Math of Product Pricing
In any conversation about product pricing, you’ll be asked about two terms: Markup and Profit Margin. Here’s what each means and the math behind the numbers.
Markup is the amount you add to your product cost to get your selling price. For example, let’s say you want to simply double your product cost to get to your final selling price. This is how it works:
|Final Selling Price||$200|
This gives you a 100% markup because you’re adding 100% of your cost to get to your selling price, basically just doubling your cost:
$100 x 2 = $200
This is a very simple and popular way to set product pricing, especially for retail and ecommerce sellers. But there may be times that you want to markup your products by a different percentage, say a 75% markup or a 150% markup. In these cases, the math isn’t quite as straightforward as doubling your cost. You’ll need to use this formula instead:
Cost + (Cost x Markup Percent) = Selling Price
For example, our $100 item with a 75% markup is figured like this:
100 + (100 x .75) = Selling Price
100 + 75 = $175
And a 150% markup looks like this:
100 + (100 x 1.50) = Selling Price
100 + 150 = $250
Determining your markup percentage and your base product cost can depend on several factors, such as wholesale costs, manufacturing costs, and overhead, which we explore below. But whatever those numbers are, now you know the math that you’ll use to apply your markup percentage to your product cost to get your selling price.
Profit margin is a percentage that’s figured on your selling price less the cost of your product. Note! Your Profit Margin percentage is not the same as your Markup percentage. This is how profit margin works:
|Final Selling Price||$200|
|Profit Margin||$100 or 50%|
So if a product sells for $200 and costs $100, you have a 50% profit margin. In the simplest terms, half, or 50% of your $200 sale is your profit, thus the 50% profit margin.
If you always double your product cost to get your selling price, you’ll always have a 50% profit margin. But that’s rarely feasible, so here’s the math you’ll use to figure your profit margin for other markups:
Commonly Used By: Retailers & Ecommerce Retailers
Manufacturer’s Suggested Retail Price, or MSRP, is another top pricing strategy used by retailers and ecommerce sellers. This is a no-brainer pricing method. Your product manufacturer sets the MSRP, and that’s how you price your product. For most goods, you’ll find that MSRP is based on the Keystone pricing strategy covered above. But, they usually drop the MSRP selling price by 1-5 cents due to Psychological Pricing, which we’ll discuss next.
Here are common MSRP examples that you’ll find on manufacturer and wholesaler price lists:
|YOUR WHOLESALE COST||MSRP|
The downside of using MSRP as your pricing strategy is that you’ll have the same prices as your competitors. So, you’ll have to differentiate your store in other ways, such as free shipping for ecommerce sellers, and exceptional in-store promotions for retailers.
Another thing to be aware of is that some suppliers actually insist that their MSRP is followed to preserve the value of their goods and brand. They will even force adherence by refusing to fill stock orders for stores selling under MSRP. This is something to be aware of when dealing with suppliers, especially if you intend to sell using any of the discounted pricing strategies that we cover below.
Choosing the Best Pricing Strategy for Your Small Business
Most businesses find that a mix of a few different pricing strategies works best to bring in customers, encourage sales, and end in a profit. For example:
- A small specialty retailer might Keystone the majority of their collection, but mark up hot sellers even more, say 150%. Then for promotions, they Discount the high-profit hot sellers to a Keystone price and still make a 100% markup. Clever!
- A store might have a set of replenishable Loss Leaders that make no profit but cross-sells private label products that carry a 200% markup. Beauty stores love this strategy. They sell low-cost replenishment items like eye makeup remover at cost, then cross-sell high-markup cosmetics and skin care.
- A specialty store struggling to attract upscale shoppers can switch to an Anchor Pricing strategy and market their store as a place to find great deals.
What’s best for your particular business depends on many factors, such as your industry, market, product line, location, business model, the list goes on. But whatever your business, you need to be sure your pricing strategy gives you enough markup to be profitable.
3. Make Sure Your Product Pricing Strategy is Profitable
The pricing strategies covered above offer good guidance on how to price a product. But you also have to ensure that the strategy, or mix of strategies, that you use result in enough income to cover your business’s overhead expenses and leave you some profit to fuel growth.
Once you figure up your average monthly overhead expenses, you’ll know how much you need to make off of product sales to break even. If, after running the numbers, you find your operating at a loss, try these 3 things:
1. Raise Your Prices
If you’re selling a decent volume of goods and your sales aren’t dependent on discount pricing, try raising some prices, particularly on your hottest sellers. This will increase your gross profits to cover your shortfall.
2. Increase Your Volume
If you’re just not selling enough product, it’s time to examine your pricing strategies. Are your prices too high? Maybe it’s time to try Anchor Pricing or set some items to Discount Promos or Loss-Leader Pricing to get shoppers in the door.
3. Lower Your Costs
It’s easy to let your costs creep up and eat into your profits. The first high-cost things to look at are your staffing needs and space. Do you need what you’re currently paying for? If not let some of it go, then see if you can increase your profits further by making smart stock buys. Don’t overbuy, but if your supplier is offering a discount, free shipping, or extended payment terms on goods that you move fast, take advantage of those buying opportunities.
The Bottom Line
There’s one hard fact about product pricing: The process never ends. The pricing methods and strategies we covered above will get you started on a path to profitability, but you must revisit, review, test, and tweak your pricing every step of the way. Your buying power will increase as your business grows, but so will your operating costs, salaries, and facilities needs. So deciding how to price a product, and the pricing strategies you adopt, will change as your business changes.
You might start with Keystone and MSRP, but as you grow, you might find that adding a collection of Loss-Leaders helps you drive far more business. Or, you might have a unique collection of goods, or develop a great private-label brand that you can sell for a markup far over Keystone. You might find that your handmade goods sell in lower volume, but at higher prices. This way you can make more per sale, and make more per hour spent creating your goods.
(A BIG THANK YOU TO THE FABULOUS KRISTA FABREGAS FOR WRITING THIS ARTICLE SO THAT WE MAY SHARE THE INFORMATION WITH YOU AND HEP YOUR BUSINESS GROW AND BECOME SUCCESSFUL! )