Pricing a product is a highly important yet deceptively tricky task. Highly important because it can determine how well your product performs on the market, thus laying the foundation for your business’s success. Deceptively tricky because while you might think you have enough experience as a consumer to come up with an appropriate number, the truth is that pricing a product requires a lot more than market comparisons and a hunch.
So what does it take to figure out your product’s worth? Let’s take a look.
1. Determine Your Gross Profit Margin Target
This is a brass tacks, bottom line strategy that most businesses employ as a first step in determining the price of a product. Gross Profit Margin is how much revenue is leftover from sales after paying operating costs of the business. Gross Profit Margin Target (GPMT), therefore, is your revenue goal. The formula for Gross Profit Margin is (P-C)/P, wherein P is Price and C is cost. Once you determine your Gross Profit Margin Target, you can plug that formula into a spreadsheet and make price adjustments as the costs of your business change.
According to Business Insider, “Most companies know the GPMT they want.” But if you don’t, you can study the GPMTs of like businesses. For example, manufacturers commonly aim for a GPMT of 50%.
2. Figure Out What The Market Will Bear
This strategy is all about maximizing profits; “What the market will bear” essentially means “What is the consumer willing to pay?” It’s a delicate dance, because pricing a product too high could open the doors for competitors to swoop in and capture the market at a lower cost, but pricing a product too low can really impact your bottom line.
“I think it’s best to avoid a race to the bottom,” says Mark Kronenberg, founder of the New York-based tutoring and test preparation company Math 1-2-3. “It’s an easy race to win, but you won’t have a lot of profit to show for it.”
To determine what the market will bear, consider:
- The uniqueness of your product
- The desirability of your product
- How easy it would be to duplicate your product
- Market competition, or lack thereof
If you have a unique and desirable product that is difficult to duplicate and there is little to no competition, you should be able to optimize profits without putting your leadership position in the market at risk.
3. Study The Competition, With Context
If you do have competition, you should study it well.
“After all,” says Inc. Magazine, “your customer most likely will, too.”
You’ll want to look at what your competitors are charging, of course, but don’t stop there; you should also identify any differences between your businesses that could impact the market price. For example:
- Are you offering additional services or higher quality materials that would allow you to charge more?
- Do you have lower overhead expenses that would allow you to charge less?
- Where are your competitors located? A bakery in rural North Carolina may set their prices lower than one in downtown Los Angeles.
What all this means is that you shouldn’t take your competitors’ prices as gospel. Your needs may be different and your value may be higher or lower. So while studying your competitors, you should study your own business, too.
4. Don’t Be Afraid to Adjust
A product’s price isn’t set in stone, and you shouldn’t be afraid to adjust based on your business’s needs and changes in the market. You should monitor pricing and profitability on a monthly basis, always keeping in mind your GPMT and staying aware of competitors that may have entered the market.
Basically: don’t set it and forget it. It takes a lot to price a product, and all that hard work will be for naught if you aren’t committed to long-term price management.
Want to learn more about pricing strategy? Check out our evening class, Introduction to Pricing Strategy.