Pricing is a complex area. Because of its complexity, many struggle to set pricing structures that support their business strategy and brand AND provide an optimal split of value between customer and the business.
Pricing is also a very emotive area – we don’t want our customers thinking badly of us or leaving us.
So how do you price your product so that customers are keen to buy AND you make a profit?
We look first at the internal costs you need to know and then at the external market and customer perception.
1) Calculate what it costs to make your product
Knowing your production costs is an critical step to ensure that you do not price your product below this figure and immediately make a loss. Ideally you want to calculate the cost for each individual product, but if this is not possible, then calculate by category or group of products with similar production methods.
If you are outsourcing your production to third party, this step should be easy. What are you being charged to make each unit of your product?
If you are making the product within your own facility, then you should calculate the costs of all the competent parts such as:
- Raw materials – ingredients, materials, components, etc
- Delivery & customs costs
- Labour required to make the products
- Packaging – the materials and any printing required. Inner and outer packaging.
- Investment in any machinery apportioned over the number of products the machine is expected to make (or in accounting terms: depreciation)
- Other indirect costs – rent, rates, admin etc
The costs within point 6 can be excluded from your pricing calculations if you wish. If you do so, you should aim for a higher profit margin to make sure you cover these costs. To include these indirect costs, or not, is a judgement based on your situation.
As you increase your production volumes, it is likely (but not certain) that you will be able to reduce the per unit cost through economies of scale. Model the anticipated costs at different production volumes: there may be a point where higher volumes actually cost you more, such as requiring additional staff.
If you are outsourcing production, negotiate reductions in unit cost with increasing volumes.
You want the costing information across multiple volume levels: your initial sales price might make a loss, but turn into a profit when higher sales volumes give you lower costs. This might impact your sales price and strategy.
2) Calculate the cost of selling your product
Calculating the cost of selling your product can be a lot more difficult. A lot depends on how you sell your products. Factors to consider include:
- Staff time – sales team costs, networking time
- Trade fairs and similar events
A new business is likely to have high cost of selling as it is relatively unknown and has not built a level of trust with potential customers that a more mature business enjoys.
Over time a business is able to work out which channels work best and within those channels, which sales steps result in a higher sales conversion. Hiring the right sales and marketing teams also takes time. For these reasons, you would expect the cost of acquiring each customer to reduce over time. Please note, that competition is an opposing factor.
The improvement in sales costs per unit can be difficult to predict. To be conservative, you could use your current costs across all volumes and assume that any cost improvements translate into profits.
For a mature business, the cost of acquiring a new customer should be easier to calculate as you have a more stable sales process.
Also consider the costs of maintaining your current customer base. Selling more products to an existing customer is cheaper than finding a new customer.
3) Undertake a competitor analysis
The next step is to look at your competitors within the market and compare what they are offering and at what price. Which of these competitors are growing and which are not growing?
A focus on understanding what the growing competitors are offering to which customer segments and how they are approaching the market can give you valuable insights.
When comparing competitors, do not just compare price. Understand what value they are offering their customers. Elements of this “value” might be:
- The physical product
- The packaging (the experience of receiving and opening – e.g. Apple products)
- The deliver speed, time slot availability, ability to change time slot etc
- Customer service
- Financing options or payment terms
- Returns policy
- The experience of buying the product
You can then compare value and price.
For a detailed and valuable comparison, we recommend mapping out how the competitors solve which of their customer problems. This analysis includes prioritising customers problems and the effectiveness of the solutions being offered. Testing can also be undertaken for key assumptions.
This exercise provides very valuable information about your competitors and helps formulate and position your product and value offering to your customer group. This can in turn inform your marketing messaging.
4) Customer perception of value
The customer’s perception of value is THE critical factor in the buying process when considering price.
In summary, if they perceive the value to be higher than the cash price, they will buy. If they perceive the goods to be of lower value than the price, they won’t. The bigger the positive gap in the customer’s favour, the more they will buy.The cost of making and selling the product may have little to do with this perception.
For example, let’s compare an Armani T-shirt with a supermarket T-shirt.
- The physical cost of the cotton, labels etc is unlikely to be much different
- The cost of design is likely to be higher for Armani but probably not hugely so
- The cost of selling is going to be higher for Armani by several multiples because they have smaller, more expensive stores and lower volumes
- The brands couldn’t be more different – the perception of Armani is luxury, expensive, exclusive, whereas a supermarket is widely available, inexpensive, for everyday wear.
From a social perspective, how would we view a person in a supermarket-branded T-shirt vs a person in an Armani T-shirt? For many people, there is a significant value in that difference which far outweighs the cost of adding a logo to the shirt.
Price is a key communication element to customers and it impacts their perception of value. How does your product’s price support or otherwise the position of your brand? Is the message to customers consistent?
Price plays a huge part in the profitability of your product. Price (vs the value perception) will impact the volumes that you are able to sell, and therefore any margins you will make from economies of scale.
Setting a price
Having determined the perceived value of your product in your customers’ eyes, and established the costs to make and sell your product, you have the framework for setting a price.
Your sales price must be higher than your costs, but within the perceived value of the product.
Within this range, you should be an attractive proposition to your customers and still make a profit.
We recommend that you understand your customers as much as you are able and to undertake testing of different price ranges where possible.
Confidence in what you are producing and the value that you are creating for your customers really helps in setting pricing. Doing your homework helps that confidence and helps you communicate the value you are giving to your customers.