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6 Strategies to Help You Price a Product or Service
Whether you’re selling sweaters or charging for your handiwork skills, your price is one of the first things a potential customer will want to know. The right strategy can help you determine the price you need to set to generate sales and earn a profit. Keep reading to explore ways to price your product or service and keep in mind that your pricing strategy is essential to include in your business plan.
Choosing a Pricing Strategy
Pricing a product or service may seem simple, but there are many factors to consider when deciding how much you should charge:
What does your customer want?
- Knowing what your target customer is willing to pay can help you make an informed choice about your strategy.
- Determining how your customer shops—whether online or in stores—could also help.
What’s the market like?
- Check out the pricing strategies your competitors are using, as well as the prices they’re offering, and see if that model works for you.
- Consider how many competitors are in the market. The more competition you have, the more aggressive you may need to get with your pricing.
- Retailing in a small local area may have a lower overhead cost than trying to retail across the country because you could save on shipping and other costs.
What’s best for your company?
- Think about your unique selling point and what you want your company to be known for—for example, great customer service, product selection, custom goods, etc.
- Consider whether you want to be perceived as a premium or value brand.
- Determine your break-even point to find out how much you need to sell to cover your costs and begin profiting.
- Offering more than one product? Determine which one may be the most profitable and capitalize on it.
What Are Overhead and Profit?
Two more factors that could impact how much you charge for your product or service are overhead and profit.
Overhead is how much it costs to start and keep your business running. This includes your start-up costs and working capital needs, including:
- Lease or mortgage payments on your premises
- Wages and salaries of permanent staff
- Utilities, including phones, internet, power and more
- Your salary
- Inventory (if applicable)
- Marketing and distribution costs
Profit is how much you make off your product or service after all costs are covered. Your total profit is what the Canada Revenue Agency (CRA) will tax you on at the end of the year.
The right price will need to be high enough to cover your overhead costs, as well as help you earn a profit. That’s why it’s important to determine both before choosing a strategy.
Tip: Determine your start-up costs and working capital (PDF) now with the Start-up Costs Calculator.
Common Types of Pricing Strategies
There are a wide range of pricing options to choose from, depending on your business. Keep in mind that you don’t have to go with just one—sometimes using more than one pricing model can help you get more sales. Here are six of the most common ones:
Cost-Plus Pricing
This is a popular strategy and a good starting point for nearly any business because of its simplicity. To use cost-plus pricing, tally up all your production costs, add a margin (a percentage of profit you want to earn) and multiply that total by how much you can produce. The number you get should cover your overhead and profit. If not, you’ll need to cut overhead costs, raise your margin or figure out a way to increase production and/or sales.
Pros
- Requires little market or consumer research
- Provides a consistent rate-of-return
Cons
- Doesn’t take into account what the competition is charging, market expectations, or what your customer is willing to pay
Retail Margin
If you are a retailer or wholesaler who buys and resells products, you’ll need to add a percentage—otherwise known as your margin—to the inventory you’ve purchased to resell. For example, if you buy an item for $100 and re-sell it in your store for $150, your mark-up is 50%. Your margin is different. This time you divide the mark-up profit of $50 by the sale price of $150. In this case your margin is 33% ($50 divided by $150).
Pros
- Knowing your margin can help you easily work out the sales target needed to cover your overhead costs
Cons
- Higher wholesale prices and margins may raise prices above what customers are willing to pay for your product or service
Hourly Rate
If your business is service-based, consider charging clients by the hour. It’s much simpler than other strategies as you won’t have any physical costs of materials or inventory to factor in, though you’ll still have fixed overhead to cover.
An easy way to calculate your hourly rate is to add up all your overhead costs and divide that number by how many hours you want to work each week, month or year.
Pros
- Get paid for all hours spent working, even if customers change the scale of the work
- Straightforward to calculate
- Provides more predictable income for your business
Cons
- Will need to provide accurate estimates to clients to avoid losing money
- Time-tracking must be accurate to establish trust with your client
Value-Based Pricing
Whereas cost-plus pricing takes into account how much it costs to produce your product or service, value-based pricing considers how much your ideal customer is willing to pay. As a result, this method works best for businesses that offer specialized or unique products or services.
When using this strategy, keep in mind that customers will also associate your brand with your product. That means things like your brand’s track record, customer service and marketing could affect the value of your product or service.
Pros
- Potential to reach higher price points
- Your brand’s positive track record and strong relationship with customers may help you achieve a larger margin
Cons
- Perceived value can fluctuate and affect your margins
- Requires significant research to determine how much customers value your brand
- Less exact than other pricing strategies
Riding Down the Curve Pricing
This is a method where you charge a higher initial price and then lower it over time. Ideal for new-to-market products or services that don’t have much (or any) competition, the main benefit of this strategy is that you’ll capitalize on the initial high demand from customers and low supply due to lack of competitors. Plus, it could help establish brand loyalty from initial customers. As more competitors enter your space or your business becomes more efficient, you can lower your price.
Pros
- Capitalize on high demand and low supply
- Potential to break even earlier when you factor in a larger initial margin
- Could help build brand loyalty
Cons
- Not effective if you’re in a saturated market
- Early customers may be frustrated—or feel duped—that they paid more than others
- Competitors could quickly enter with lower prices
Penetration and Discount Pricing
With penetration pricing, you would sell your product or service at a lower price for a limited time to attract clients. Similarly, discount pricing is likely a strategy you’re familiar with—it’s when brands offer sales, coupons or other markdowns to sell their goods.
Pros
- Potential to reach a larger client base
- Helps you offload excess inventory or out-of-season products
Cons
- Lower prices will affect your profit and margin
- Your brand could be labeled as a discount brand, which could deter people from paying full price
How to Calculate Working Capital
No matter which pricing strategy you use for your business, aim to achieve the best margin possible so that you can break even and start profiting faster. Check out a few ways you could improve your margin:
- Offer extras that the competition doesn’t such as guarantees, delivery, more expertise and better after-sales support
- Lower your overhead by doing things like renting out extra space or machinery you don’t use daily
- Reduce input costs such as raw materials, staff, or inventory without impacting the quality
- Find ways to sell more products to help distribute production costs across more sales
Pricing Tools and Resources
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