Knowing how to price a product perfectly is essential. It’s vital to ensure you are not overcharging your way out of the market or undercharging your way into your profit margins. Yet, despite how important it is to get the pricing right, it’s surprising how many online store owners wing it.
If you’re just copying your product prices from your biggest competitors or guessing your way through your new product line pricing, then this post is for you! The secret to pricing your products accurately is looking at it more as a strategy or a science.
Today, we are giving you a three-step strategy that enables you to find the sweet spot between market pricing, your expenses and your long term profit goals. A strategy fitting for any eCommerce entrepreneur, regardless of whether they are new to the industry or established brands looking to expand their products.
Step 1: Find Your Base Price
The first thing you need to do when pricing a product is finding a base price model that works for your brand and the niche you are selling in. There are three main base-pricing strategies you can choose from: competition-based, cost-based and dynamic pricing. Let’s look at each of these separately.
What is Competition-Based Pricing?
Sometimes referred to as market-oriented, the competition-based pricing model is where you compare various similar products in your market to find pricing that works for you. Here, you could either go higher or lower than the average of your competitors’ pricing, depending on how your products and brand compare in quality, functionality, etc. or how you would like your brand to be perceived.
Here are three scenarios:
Let’s say you are a brand-new online store selling in a highly competitive niche. You could use this pricing strategy to price your products below the market, as a way to lure customers from the competition.
You want to highlight to your potential customers that your products are more prestigious, of better quality or have superior functionality – you could price your products above the market.
If you want to stay competitive while also maximizing profit, then you would copy the market pricing, selling your products at the same price.
All three strategies will have their own pros and cons, but overall you want to be very clear about your product costs and how your products compare in quality to your competition before you jump into competitor-based pricing.
Additionally, it’s important that you aren’t just blindly copying your competitors’ prices; instead, look at it like modeling their pricing. What do I mean by this? That you need to consider all the factors before just copying a price. Compare where they are selling, who they are selling to and what they are selling (quality) – to your store and market. Furthermore, you will also need to take into consideration your specific costs and profit goals, which we will lay out in step 2.
What is Cost-Based Pricing?
As the name suggests, this pricing strategy is based on a product’s total cost plus a markup percentage. This is the simplest and most used pricing strategy. However, when using this pricing strategy it is crucial to account for all your costs. This means keeping a close eye on costs like Google Search campaigns, ensuring that on average, you aren’t exceeding your price.
Let’s go through an example where you are starting an online clothing store and planning to sell print-on-demand t-shirts. Here is a breakdown of what your costs could be for one t-shirt:
Manufacturing costs: $27
Overhead costs: $2
Labor costs: $2
Total cost: $31
Then, let’s assume that you have researched your niche and decide to add a 50% markup on your product. Your product price could be: $31 x (50% of $31) = $15.50.
What is Dynamic Pricing?
Dynamic pricing is where you create a flexible pricing strategy that is based on market demands. Also, sometimes referred to as time-based pricing, this base price strategy involves adjusting pricing at different times of the day, week, month or year. If you sell your products on Amazon as well, you are probably already familiar with this concept. Or if not, think of your Black Friday and Cyber Monday competitive pricing strategies to give you an idea.
Side Note: If you are going to use this strategy more frequently, though, along the lines of Amazon’s model where prices are adjusted in real-time based on the market, stock levels, timing and competitors, you’re going to want to invest in a tool for this. Here are some to check out:
When it comes to choosing your base pricing model, you don’t need to pick just one. You can come up with a strategy that suits your specific market and audience by testing each or a combination of each of these strategies, but we will get to that in step three.
Step 2: Bring Long-Term Profit Into the Equation
Next, you want to asses the bigger picture by looking at your long-term profit goals for your product. This means taking your current pricing for products and comparing it to your current metrics to make sure that you are on point to firstly, cover your costs and secondly, turn a profit.
Let’s say you’re using a markup percentage strategy; ask yourself how many products you would need to sell in order to cover all your overhead expenses. Using the print-on-demand clothing brand store example again, here’s a list of what your overhead costs could include:
- eCommerce platform, hosting
- Rent and facility for your office (for an intermediate established online stores with a base)
- Freelancers and other service providers whom you outsource to, such as content writers or Shopify developers
- Marketing (PPC, email, video, etc.)
- Shipping and fulfillment
- Your personal income
- Your payment gateways and transaction costs
- Any additional accounting or office apps that don’t fall into the above, like Trello
You want to calculate these per month, to get an exact total of what your costs are each month. Then take your sales for the month and see how many products you need to sell at the current price to meet those expenses and your profit goals – and adjust accordingly. If you see that you are meeting your sales number targets but aren’t making a profit or covering costs, it’s time to tweak your pricing to ensure long-term profitability.
Step 3: Experiment With Pricing to Grow Market Share
Lastly, you want to experiment with your pricing. This doesn’t just mean testing your prices within your target audience and market; you also want to test some strategies that will help you gain market share in your niche.
Your ultimate goal is to maximize profits while also gaining market share. This means having a good understanding of concepts like price elasticity and consumer surplus and then experimenting with pricing options (using tools like promotions, for example) to find the magic middle between market and profit. Let’s look at these two concepts in more detail.
Price Elasticity of Demand
This is the measurement of changing quantity demands for a product in relation to the price. If a product’s pricing change results in more demand for the product, then you would call that ‘elastic.’
Next, let’s look at the consumer surplus. Simply put, this is the difference between what a potential shopper is willing to pay for a product versus what the market dictates they should pay. If you want to get into the economic science of the concept, this video is a great place to start.
Why are these two things so important? By lowering your overhead costs per product (such as improving ROIs on your ad spend or outsourcing fulfillment, for example) and strategically increasing your product prices, you can decrease the consumer surplus (the gap between how much they spend and how much they are willing to spend).
Therefore, although demand elasticity can help you lower your prices strategically to push more product volume, it could increase your surplus. That doesn’t mean you shouldn’t be using it, but you want to use strategically – which is where well-crafted promotions come in. The bottom line is that yes, lowering your prices does have its benefits – but you want to do it strategically.
Another aspect to consider with regards to how to price a product for profit and market share is your conversion rate.
Let’s say you have tested different pricing strategies to find those unicorn products – products that customers are willing to pay more for, that are less elastic – doesn’t require use drops in prices to increase quantities. You also have an idea of how many you need to sell to cover your overhead costs and profit goals. Your conversion rate goals will help you assess how much traffic you will need to achieve that, and how to adjust prices for varying rates.
In other words, the lower your conversion rate is, the higher your prices will need to be to ensure you are meeting your overhead needs.
After testing, you could find that option 3 below (10% conversion) is your base product price, suiting the market, customer, profits and covering costs.
And what about those customers willing to pay $50 or $100 for the product, as shown in the above table? That’s where your promotions come in and why you should be aiming for different price strategies for various products, markets, times of the year, etc.
Here are some combination pricing strategies to get you started:
This is where you display the regular price while showing the ‘new’ lower price. This strategy does work well if you are actually running promotions. If you use it continuously, shoppers will catch on to the fact that it’s fake and this will hurt your brand (and your sales) in the long run.
This is where you start at a higher price and scale down with a sale, or an incentive discount for new shoppers, for example. A popular eCommerce use for this strategy is an abandoned cart campaign where you may send an automatic email with a discount to get the conversion.
This is a more aggressive pricing strategy, designed to cut into a market share at the expense of profit. In other words, you specifically set your products at a loss to attract new shoppers from your competitors. This is often used by new stores entering a highly-saturated market. And an example of a brand that has dominated with this? Yes, you guessed it: Amazon.
There you have it, how to perfectly price products in just three steps. However, like with any aspect of an eCommerce business, expect fluctuations. Keep a close eye on those eCommerce KPIs and optimize and experiment regularly.
And remember, the best way to keep your advertising overhead down is to optimize your campaigns for awesome ROIs, which doesn’t have to take work when using the number one eCommerce traffic tool – Traffic Booster.