Pricing Strategy, How to Price your Products or Services?
Pricing your product or service properly and relative to your market can mean a great success. While doing the opposite can mean great frustration and eventual failure. You have worked so hard to build your product or service by paying a lot of attention to the details. So, do the same for the pricing of your product or service by creating the best pricing strategy.
As a matter of fact, there is a tremendous amount of information on pricing strategies and on how to price your product or service. Moreover, this information can be complicated as some people described pricing as an art and a science. In my opinion, pricing is all about science.
My objective in this post is to introduce you to a pricing strategy that is based on science. Additionally, I want to help you price your product and services effectively. So, keep reading!
Strategies for Pricing your Products or Services
Here is a pricing equation that has always worked for me. You can try it too and tell me what you think.
Price = Cost of Goods Sold (COGS) + Overhead + Profit
Profit = (COGS + Overhead) * (Unforeseen + Growth + Shareholder ROI + Brand Value) * Supply & Demand * Marketing Initiative.
Here are the main elements of a good pricing strategy:
1- Establish your base.
2- Price your products or services.
Establish your base by Knowing:
1- Your competition
The first step to your pricing strategy is to know the market you are selling to, your competitors, and their marketing and price strategies.
You also need to know where you are relative to your competitors in terms of value, features, and functions. To understand this better, you can answer the following questions:
a- Are you selling the same product as your competition and to the same customer?
b- Are you different than your competitors? Do you have a better service, better features, and functions or perhaps a better brand than your competition?
c- Are you leading or lagging the market with your product or service?
d- Are you unique with your offering?
2- Your cost
Next, you would need to know your cost which is essential for your strategy. This would consist of the following:
a- Cost Of Good Sold (COGS): This is the cost that is specifically related to your products and services.
b- Overhead cost: This is the cost of your operation, other than your COGS.
3- Your position in the market
Then, find out where you stand in the marketplace. For this, you can answer the following questions to understand your position better:
a- Are you a latecomer to the market with the same product or service as your competition targeting the same customer?
If so, it is going to take much more than a good price strategy to make you successful.
b- Are you at par with your competition selling the same product or service?
If so, pricing may matter somewhat. But think of some differentiation to make you and what you are selling better. This is because the last thing you want, is to sell your service or product based on lowering your price. In fact, this will turn out to be a race to the bottom and no one will win.
c- Are you leading the market with your product or service and the competition is not even close?
If so, you can ask for a premium price. Just be careful not to gouge your customer.
d- Are you unique in your offering? Is there no one else offering the same thing and competing with you?
If so, you can price at a premium.
e- Is your brand stronger than anyone else? And does the market associate high quality and high value with your brand?
If so, you can price your product or service at a premium.
Once you have found out and established a base regarding what you are offering, and you have acquired good knowledge about your competition, the next step is to price the product or service that you are offering.
Pricing your products or services
There are many ways to price your product or service. And in order for you to do it effectively, you will need to know a few things. These include: why you are doing it, its impact on the market, your bottom line and the future of your company.
The variables that you will be thinking about for your price are:
1- Total Cost.
2- Unforeseen conditions.
3- Growth.
4- Shareholder Return on Investment (ROI).
5- Brand Value.
6- Supply and Demand.
7- Marketing Initiatives.
Let us talk about each in details:
Total Cost
Knowing your cost and keeping track of it will give you a good understanding of your starting point.
To know the cost, you need to know the COGS and Overhead Cost. Your Total Cost is the addition of the Cost of Good Sold (COGS) and Overhead Cost. They are explained below:
a- Cost of Goods Sold: This is all the cost that is directly related to your product, such as material, labor etc.
b- Overhead: This is all the cost that is not directly related to your product. It includes things such as office staff salaries, rent, utilities, marketing cost, sales cost etc.
Unforeseen conditions
More often than not, most companies don’t see every cost that is associated with the operation of a business. And as a minimum, you should include a percentage profit that is related to an unforeseen cost of about 1% to 2%. In short, the number should not be large.
Growth
If growing the company is your intention, then growing requires healthy profits to pay for and stimulate the growth of the company.
Depending on your yearly growth target of the company, you will need to calculate the cost for your company’s growth and add it to your profit.
Shareholder Return on Investment (ROI)
Brand value
Depending on your product and your company position in the market, the brand has a certain value. And this value must be reflected in your profits.
Some brands command high profits and some command none. So, this is a hard variable to assign a number to. Nonetheless, I believe that you should have a number, and test the market repeatedly until you find the right number.
Supply and Demand
The profit number needs to take into consideration the supply of the product or service and the demand of the market.
If your product is in high supply and you have heavy competition, then you can’t ask for a higher price than the market price. But if the demand for your product is very high, and the supply is limited, that is when you can price your product at a premium.
In short, you will need to experiment with this number to get to the right price. Moreover, this price should be the one that the market can bear, and the customer will accept.
Marketing Initiatives
Every company has a marketing strategy. And if you do not have one yet, you should prepare it soon. Marketing strategies always affect the product price. Basically, this variable will give you the flexibility to manipulate the price depending on an overall marketing initiative.
Examples of that:
To draw customers into your store, you may want to price your product as a loss leader. This way you may lose money on one product, but you will be able to make money on another. And the overall Net-Net will bear higher profits.
Pricing equation:
Back to the pricing equation for the pricing strategy that I have used. This equation has always worked for me. It gave me the visibility of all the pricing variables that I was concerned about. Moreover, it allowed me to keep an eye on the various cost and profit elements.
With this equation, I was encouraged to review the variables of the price that affected my business. In other words, it kept me and my prices sharp and relevant. Here is the equation again:
Price = Cost of Goods Sold (COGS) + Overhead + Profit
Profit = (COGS + Overhead) * (Unforeseen + Growth + Shareholder ROI + Brand Value) * Supply & Demand * Marketing Initiative.
Let’s do an example to show how this equation works:
Cost of Goods Sold (COGS) = $100.
Overhead Cost = $30.
Total Cost = $130.
Profit:
Unforeseen = 1.5%, in case some cost was missed.
Growth = 10%, growing the business modestly.
Shareholder ROI = 10%, a modest return on investment.
Brand value = 3%, modest brand value.
Total Profit % = 24.5%.
Supply & Demand= 1.5 (This is a multiplier.)
Note: In this case, I am assuming there is a high demand and a limited supply. So, that is why the multiplier is greater than 1. On the other hand, if the supply is high and the demand is low, then the multiplier should be less than 1. Which would be a fraction depending on the market (e.g. 0.7).
Marketing Initiative = 1 (This is a multiplier.)
Note: In this case, there is no marketing initiative. And it has been set to neutral, which means that it will not affect the profit. Additionally, if there is a marketing initiative, and you want to lower the price for a limited time you can set it to a fraction of 1 (e.g. 0.4).
Moreover, if you want to use this product as a loss leader, then you can set it to negative fraction of 1 (e.g. – 0.5). On the other hand, if you have a marketing campaign to sell a high quality items, you can set this variable to higher than 1 (e.g. 1.6).
Profit Percentage
Now, let’s calculate the Profit %.
The formula for this is: (Unforeseen + Growth + Shareholder ROI + Brand Value) 24.5% * (Supply & Demand) 1.5* (Market Initiative) 1= 36.75%
Profit = Total Cost * Profit% = $130*36.75% = $47.8
Price = Total Cost + Profit = $130 + $47.8 = $177.8
This will give a profit margins of = Profit/Price = $47.8/$177.8 = 26.9%
In short, the pricing equation provides you with a good visibility of your price variables. This is what would help you to set your price that is relevant to your market.
Once you come up with your price always compare it to your completion. Ensure that the market is willing to pay the price you are choosing. And be careful not to price gouge your customer. On the whole, always price your product and service fairly.
Your cost
The cost in the pricing equation is only important to you. In short, the customer does not care about your cost. All the customers care about is that if they are getting sufficient value for the money they are spending.
So, the price of a service or product from a customer perspective is different. And it does not have anything to do with your cost. The only reason your cost is important is because you need to know your cost relative to your price. And if your price is high because your cost is high, then you need to figure out a way to reduce your cost.
Test your Price
Price is never a constant. This means that it should change with time.
Find your price based on the method we discussed so far. Then, test it in the market and see how it is doing. If the price is doing very well, adjust it a little bit higher and test it again. Do this until you come up with the most optimal price.
Conclusion
Pricing your product or services is perhaps simpler than you think. However, you need to pay attention to the details.
In fact, you can establish a pricing strategy that can be long-lasting by using this equation. Moreover, the variables in this equation also allow you to keep an eye at all the cost and profit elements that can affect your business.
So, with this, do not forget to monitor the changing market conditions and review your pricing strategy often. Tell me what you think in the comments section bellow. Happy Pricing!
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