How to price a product: strategies for pricing your products

If you’re wondering how to price a product, here’s an overview. We run through different elements of strategic pricing, including penetration pricing and price skimming.

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How to price a product

It can be difficult to know how to price a product, especially when you’re starting out. But if you’ve done market research and know how much it costs to produce and sell your product, you’re almost there.

The science behind pricing involves your costs, as well as other data, including how much your competitors are charging for their products.

But there’s an art to pricing too, which involves the value customers perceive your product to have, as well as your overall business objectives.

That being said, it’s important not to overthink pricing your product. While you should approach changing prices carefully, it’s possible to alter your prices in the future when you have more data.

Your fundamental objective is to price your product so that your business can continue, make a profit, and sustain your cash flow.

Strategic pricing: guide to the different strategies

Here are strategies to help you price your product and make a profit (and therefore a success of your business). Use this overview to carry out further research if you need to, including a competitor analysis or SWOT chart.

Cost of goods sold (COGS) for cost-plus pricing

Businesses that sell physical products and carry an inventory will need to know their cost of goods sold (COGS).

Understanding COGS can help you price a product and maintain a steady cash flow.

You only include costs involved with providing a product to customers, excluding those that aren’t directly or indirectly involved in production. Xero says to look for expenses that “only occur when a service or good is provided” or that “go up and down as sales go up and down”.

These are variable costs and won’t usually include rent for your premises, or fixed staff wages, for example.

Variable costs might include:

• supplies
• transport
• manufacture
• storage
• distribution

Once you know the COGS, you can then add your profit margin. This is cost-plus pricing. You can express this purely in monetary terms or as a percentage.

If you’re looking at a 30 per cent profit margin, take your COGS and divide it by one minus your profit margin as a decimal. So if your COGS is £15.50 then the calculation is:

• £15.50 / (1 - 0.3) = £22.14 (you might choose to price your products at £21.99)

When choosing your mark-up, you should take fixed costs like rent and other overheads into account. You should also know how much money you hope to make.

It’s important to understand your competitors too, because if your mark-up ends up being way more than what others are charging, customers won’t have a compelling reason to shop with you.

Cost to sales formula

The COGS also comes into play in more formal business accounting, having implications for your cash flow.

There’s a specific formula to get to grips with here, also known as the cost to sales formula.

You calculate this over specific time periods, for example monthly or yearly. The cost to sales formula is:

• (starting inventory + additional inventory) - ending inventory = COGS

Penetration pricing

What is penetration pricing? A penetration pricing strategy involves setting a low initial price to drive people to buy your product, potentially with the goal of raising prices in the future.

This strategy can take your competitors off guard. It can encourage customers to switch from your competitors’ products, giving you the chance to build loyalty.

You might make less profit in the short-term but over the longer-term, you’ll benefit from increased market share and recognition built during the penetration pricing phase.

Penetration pricing advantages

• increased word-of-mouth and recognition
• you have to focus on productivity and production efficiencies to maximise profit
• it can back your competitors into a corner, as the already low price makes it difficult for them to react and put a similar strategy in place

Penetration pricing disadvantages

• sales may need to be high to justify the strategy
• it’s more difficult to increase prices later on than lower them
• loyalty may be more difficult to build if customers are simply after a cheap product
• competitors will end up fighting back

Penetration pricing examples

• streaming services often launch with a free trial then a low initial price to encourage sign ups – for example Disney Plus launched in the UK at £5.99 a month or £59.99 for 12 months, cheaper than Netflix’s £9.99 a month standard plan
• smartphone manufacturers have used penetration pricing to build brand loyalty – for example, OnePlus launched the OnePlus One at £229, much cheaper than similar phones at the time, and have gradually increased the prices of subsequent phones
• video game manufacturer Nintendo launched its Wii console at £179.99 in the UK, capitalising on the hype about its new motion controls – Nintendo increased the price to £199.99 later

Price skimming definition

What is price skimming? Price skimming involves setting the highest price that customers will initially pay for your product, then lowering it over time.

The idea is that you target different segments of the market each time you lower the price. If you’ve built word-of-mouth or customer loyalty already, ‘early adopters’ will be happy to pay a high price. After that, your strategy shifts to target more price-sensitive customers.

Price skimming advantages

• a high initial price contributes to the perception of a quality brand our product, with early adopters building positive word-of-mouth
• you can recoup research and development costs quicker with a higher initial price
• you can use different marketing strategies to attract different customers at each price level

Price skimming disadvantages

• your product has to be a quality product to justify the higher price
• your initial customers may be turned off if the price decreases dramatically too quickly
• you have to have customers prepared to pay for your product whatever the price

Price skimming examples

• in the US, Apple launched the iPhone at $499 for the 4GB model and $599 for the 8GB model, to huge demand. But two months later, Apple lowered the 8GB model to $399

Competitive pricing

A competitive pricing definition is a strategy that involves setting prices based on what your competitors are pricing. This also ties into your business strategy. For example, if your strategy involves being the cheapest provider, you’ll set prices slightly lower than your competitors.

And if you pride yourself on your customer service, you have to work out the mark-up that justifies in relation to your competitors.

It helps to have a well thought-out business plan that establishes how your business is going to position itself in relation to its competitors.

This strategy works if there’s a particular price that customers expect to pay for a certain product. You can set your price within a certain range around that point.

Competitive pricing examples

• sticking with smartphones, it’s useful to analyse Apple and Samsung’s pricing tactics, who are direct competitors – Samsung’s S21 Ultra is £1,329 while Apple’s iPhone 12 Pro Max is £1,099, which sends a message that Samsung’s higher-end phone is better than Apple’s

Psychological pricing

For a psychological pricing definition, it’s a strategy that involves tapping into behavioural psychology to set prices. It’s often used more as an advertising and marketing strategy rather than a long-term pricing strategy.

It’s easiest to explain with some psychological pricing examples:

Psychological pricing examples

• buy one get one free – this influences behaviour as it entices customers by offering them more than they perhaps need or want, plus it’s often a limited-time offer
• charm pricing – this changes perception of a price, for example £1.99 is essentially a £2.00 price point, but customers see the £1 first and feel that it’s cheaper
• exclusivity – digital marketing sometimes employs exclusivity, for example emails suggesting that a particular user has been ‘chosen’ to receive a deal

Psychological pricing advantages and disadvantages

Psychological pricing advantages include:

• it simplifies the decision making process for customers, helping them buy products quickly
• sales and deals can bring positive attention to your brand
• if you time a sale or a deal effectively with demand (for example, over the summer or Christmas), you can make a big profit despite selling your product for less

Psychological pricing disadvantages include:

• customers may end up seeing through your tactics, especially if deals or sales aren’t as limited or exclusive as you claim
• while not a disadvantage as such (as they protect customers), there are advertising standards that you need to be aware of, for example the CAP code
• it can often be a short-term solution designed to increase sales, rather than a long-term pricing strategy

Can product liability insurance protect your business?

When you sell physical products to the public, mistakes and accidents can happen. If a product your business designed, sold or supplied is faulty and ends up causing injury or damage, product liability insurance can cover the resulting claim.

At Simply Business, you can build a flexible business insurance policy that includes product liability insurance. Why not get a quote in seven minutes?

Would you like to know more about how to price a product? Let us know in the comments below.

Photograph 1: Ivan Traimak / stock.adobe.com/uk/Photograph 2: amnaj / stock.adobe.com/uk/