Product Pricing
Pricing a Product Correctly
Definition: To establish a selling price for a product
No matter what type of product you sell, the price you charge your customers or clients will have a direct effect on the success of your business.
Though pricing strategies can be complex, the basic rules of pricing are straightforward:
- All prices must cover costs and profits.
- The most effective way to lower prices is to lower costs.
- Review prices frequently to assure that they reflect the dynamics of cost, market demand, response to the competition, and profit objectives.
- Prices must be established to assure sales.
Before setting a price for your product, you have to know the costs of running your business.
If the price for your product or service doesn’t cover costs, your cash flow will be cumulatively negative, you’ll exhaust your financial resources, and your business will ultimately fail.
Markup and (gross-profit) margin on a single product, or group of products, are often confused.
The reason for this is that when expressed as a percentage, margin is always figured as a percentage of the selling price, while markup is traditionally figured as a percentage of the seller’s cost.
The equation is:
(Total sales / Cost of sales) / Cost of sales = Markup
Using the numbers from the preceding example, if you purchase goods for $300 and price them for sale at $1,000, your markup is $700.
As a percentage, this markup comes to 233 percent:
($1,000 / $300) / $300 = 233%
In other words, if your business requires a 70 percent margin to show a profit, your average markup will have to be 233 percent.
You can now see from the example that although markup and margin may be the same in dollars ($700), they represent two different concepts as percentages (233% versus 70%).
More than a few new businesses have failed to make their expected profits because the owner assumed that if his markup is X percent, his or her margin will also be X percent.
The Ultimate Product Pricing Strategy Guide for Small Businesses
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
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
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:
| Product Cost | $100 |
| Markup Amount | $100 |
| 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 overheads.
Profit Margin
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 |
| Product Cost | $100 |
| Profit Margin | $100 or 50% |
So if a product sells for $200 and costs $100, you have a 50% profit margin.
Markup vs. Profit Margin – Which Will You Use?
On a daily basis, the markup calculation is what most small businesses, especially retailers, use to price products.
But your bookkeeper or accountant, or accounting software is sure to mention profit margin.
If you don’t know the difference between markup and profit margin and use your markup percent when asked for your profit margin percent, you’ll end up with bad accounting numbers.
So, it’s important to understand that your markup percentage and profit margin percentage are not the same and that the math to get to each number is different.
Know the Common Pricing Strategies for Your Industry
Knowing which pricing strategies apply to your industry can simplify how you price a product, minimize the math you need to do, and give you a window into your competitors’ pricing strategies.
Here are 7 commonly used pricing strategies and the types of businesses that use them the most.
Keystone Pricing
Commonly Used By: Retailers & Ecommerce Retailers
The term Keystone Pricing means a standard 100% markup, or doubling a product’s wholesale cost, to get the selling price.
Keystone Pricing Math: Cost x 2 = Selling Price
Keystone pricing is the retail pricing rule-of-thumb and also extends to retail ecommerce.
Keystone is a simple pricing strategy to apply, but you need to ensure that your Keystone profits will cover your basic operating costs, which we cover below.
Generally, retailers and ecommerce sellers use Keystone pricing as a base markup on most goods, then apply higher markups or discounted pricing to certain items based on demand, volume, and competition.
MSRP
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 |
| $2.00 | $3.95 |
| $10.00 | $19.99 |
| $200 | $399.95 |
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.
Psychological Pricing
Commonly Used By: Retailers, Ecommerce Retailers, Big Box Stores & Discount Chains
Studies have repeatedly shown that customers feel a psychological pain of loss when they part with their money.
But certain pricing strategies actually alleviate this mental barrier and can even create perceived value that drives more sales.
Studies show that shoppers feel better about buying something for $3.95 vs. $4.00.
In fact, prices that end in odd numbers like 5 and 9 always beat out prices that end in even numbers in these studies.
It seems crazy to think that pricing something 1-5 cents below a whole dollar amount makes customers feel better about making a purchase, but it does.
So, whatever pricing strategy you settle on, MSRP, Keystone, or another that we discuss below, remember to apply Psychological Pricing strategies as well.
Discount Pricing
Commonly Used By: Retailers, Ecommerce Retailers, Big Box Stores & Discount Chains
Stores using Discount Pricing strategies regularly sell goods at prices under their competitors’ Keystone or MSRP prices.
Discount Pricing drives entire businesses, think Dollar Stores, Big Lots, and Home Goods. Discount Pricing is best for volume-driven businesses that can garner lower prices from suppliers due to volume purchasing.
For the small retailer, an overall Discount Pricing strategy can leave you with razor-thin profits that easily dip into losses.
But occasionally discounting prices via sales, markdowns, seasonal specials, and coupons are excellent tools.
With them, small businesses can kick-start drooping sales, unload stale stock, and take advantage of seasonal shopping trends.
Loss-Leader Pricing
Commonly Used By: Retailers, Ecommerce Retailers, Convenience Stores, Big Box Stores & Discount Chains
Following on the heels of Discount Pricing is Loss-Leader pricing. Loss Leaders are select products that make little to no profit or even sell at a loss.
The purpose is to have a few great deals that draw buyers in with the hope they’ll also buy profitable goods.
Think of Amazon’s Black Friday, Cyber Monday, and Prime Days rock-bottom TV deals.
These are Loss Leaders that bring buyers to Amazon in droves, where they also buy profitable goods.
At least that’s the plan.
This is another iffy tactic for small businesses since you’re taking a chance that your profits on other items sold will cover your Loss-Leader costs.
But, if you can merchandise your profitable cross-sell or upsell items well, Loss-Leader pricing can certainly lead to higher sales volume.
Anchor Pricing
Commonly Used By: Discount Chains
Anchor Pricing is another discount pricing strategy where you display a Regular or MSRP Price and Your Lower Price on all goods that you sell.
Anchor Pricing helps you create an image in shoppers’ minds that they will always get a lower-than-retail deal when they shop your store. Marshalls and TJ Maxx both use this pricing strategy storewide.
Anchor Pricing can actually work well for small sellers.
It’s especially useful if you sell in a niche that has competition, but not so much that you have to substantially lower your prices to deep discount levels.
Often, a standard storewide 5% to 10% Anchor Pricing discount is enough to create a memorable sense of value that brings shoppers back for more.
Cost Plus Pricing
Commonly Used By: Wholesalers, Manufacturers, Artisans & Private Label Sellers
In Cost Plus pricing, you apply a standard markup percentage to your total product cost.
Here, your product cost combines all applicable manufacturing, material, shipping, storage, and overhead expenses, then adds a percentage markup on top.
Cost Plus Pricing Math:
Cost + (Cost x Markup Percent) = Sale Price
Cost Plus Pricing for Wholesalers
Wholesalers usually add a flat percentage markup to all goods that pass through their hands.
A Cost Plus 15% is a common wholesale or middleman markup on most consumer goods, but of course, that can vary depending on your industry.
Cost Plus Pricing for Manufacturers, Artisans & Craftsmen
Cost Plus can be a useful pricing strategy that applies a consistent profit percentage to every product.
This profit amount is added to the product’s total cost of production, which includes materials, labor, and general overhead.
The markup can be different too, depending on the buyer.
A manufacturer might sell bulk goods to wholesalers at a Cost Plus of 100% just like a Keystone markup.
But they can also sell in single units directly to consumers on their website at a Cost Plus of 300%.
This way, they make more money per unit on the smaller sales.
Cost Plus Pricing for Private Label Sellers
Private Label sellers need to mark up products substantially to be competitive on multichannel marketplaces like Amazon, Walmart, eBay etc.
For these sellers, a Cost Plus pricing strategy can be a useful tool.
These sellers contract with manufacturers to produce goods in quantity at a very low cost, then apply a large markup, usually 200% to 300% to the cost to arrive at a competitive, but profitable, selling price.
Cost Plus helps these sellers set a standard markup percentage to their goods on top of total costs: manufacturing, shipping, packaging, and storage.
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.
- 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.
Overhead expenses that you need to cover include:
- Rent or facilities costs
- Utilities
- Staff and contractor costs
- Marketing costs
- Professional fees, licenses, or permits
- Inbound shipping on goods
- Packaging or shipping supplies
- Store decor or website maintenance costs
- The amount you need to extract from the business to live on
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 you’re 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.
Remember that you can automate much of what we’ve discussed in this article by different utilizing tools.
Software that enables you to change prices on the fly and automatically keeps track of your inventory will go a long way toward saving you time and money as you run your business.