There are few things as exciting as releasing new products. But for your business to be successful, you need to make sure you aren’t just giving those products away.
Today I’ve gathered a few simple formulas which can help you better understand the maths behind pricing, which will help you give your customers a fair price while you stay profitable.
The most essential part of pricing is understanding the math. If you sell products too cheaply, you run the risk of not covering your costs. Ask for too much money and you risk not selling any product.
To help you out I’m going to explain two key terms here; markup and profit margin. Here’s the math made easy.
Put simply, mark-up is the difference between how much it costs to make a product and how much it sells for.
For example, you might decide to double the price it takes to manufacture a product to reach your selling price. That would be a markup of 100%, or a Keystone markup. Here’s a breakdown:
|Final Selling Price||$200|
In the early days of retail, keystone actually referred to two mark-ups. The supplier would pay $25 to make a product, would sell it for $50 to a retailer, and a retailer would mark it up again by 100%, selling it for $100.
While it used to be common practice keystone pricing doesn’t work for all businesses. In highly competitive markets you may need to price your products lower.
If you want to price your products with a different percentage, such as 150% or 75%, you can use this formula:
Cost + (Cost x Markup Percent) = Selling Price
For example, a $100 item with a 75% markup would use a formula like this:
100 + (100 x .75) = Selling Price
100 + 75 = $175
In order to determine by how much you should markup your products you need to know your wholesale costs, overhead and manufacturing costs.
The profit margin is how much your revenue exceeds your costs. Just because you sell a product for $100 does not mean you have a $100 profit; you will still need to pay for the original cost of the product. Here is how it works:
|Final Selling Price||$200|
|Profit Margin||$100 or 50%|
Therefore, if a product sells for $200 but cost $100 to make, you will have a 50% profit margin. To work out your profit margin using other percentages use this formula:
(Selling Price – Cost) ÷ Selling Price = Profit Margin
For example, if a $100 item cost with a 150% markup sells for $250, it’s profit margin would be :
(250 – 100) ÷ 250 = .60
This is a 60% Profit Margin
Depending on your personal preference you can use either profit margin or markup to price your products. Keep in mind that the two are different and there are different processes to get to them!
Now that you have a basic understanding of profit margins and markups I’m going to run you through a few of the most commonly used methods of pricing.
Manufacturer’s suggested retail price / MSRP
MSRP is a very popular pricing strategy mostly used by retailers in both brick and mortar and online stores.
This is one of the easiest ways to price products; your manufacturer recommends a price and you sell for that price. Usually the recommended price is a keystone price (a 100% markup), but most retailers will drop the price by a few cents to make it seem like a better deal.
For example, the wholesale price of a product might be $2, making the MSRP $4. But in order to maximize sales, retailers often drop the price by 1-5 cents, so the product will end up being sold for $3.95.
Keep in mind that some suppliers will force you to price products based on their recommendations.
After all, if their products are sold at a heavy discount by retailers then the perceived value of their products may fall. Depending on your manufacturer/supplier you won’t be able to use some of the other methods I’ve listed here.
Discount pricing is when retailers sell their products for under the keystone or MSRP price. Discount pricing is a strategy which relies on huge amounts of sales. This is a method often used by dollar stores.
For small businesses, the number of sales might not be large enough for this tactic to make a profit. While this strategy is usually only reserved for larger sellers, you can always offer discount prices for short periods of time, such as during seasonal sales.
Loss-leader pricing is when certain products are sold to make little or no profit. The idea is that potential customers will see the deal, and jump onto your website to purchase the product. Then, they’ll be sucked into buying other products which will make the transaction worthwhile for you.
This can be a risky move for small businesses. But, if you are able to upsell your items, or cross sell your other items, then it might be a worthwhile tactic.
Anchor pricing can help you create the illusion that your products are cheaper than anyone else’s. The tactic works like this; you label all of your products with the manufacturer's recommended price, or the Keystone price, and then charge less.
That way customers who buy from you constantly feel that they are getting a great deal. This is a tactic which can work very well for small sellers. Often a price that is just 5-10% lower than competitors is enough to create repeat customers.
No matter which tactic you decide on, try to use this simple psychological trick. Studies have shown that people actually feel pain when they part with their money! However, if they buy a product with a price that ends in 5 or 9, this pain is lessened.
So, whatever you do, make a note to drop your prices by 1-5 cents. A product that is sold for $9.95 seems like a much better deal than one that is sold for $10, despite the minimal amount.
What will work best for you depends on what industry you are in, and what your competitors are doing. Have a look at similar products to your own and try to work out what tactics their retailers are using.
Ultimately, most businesses use a mixture of these tactics. For example, they might use Keystone prices on most of their products and discount pricing on their more popular items. What you choose is ultimately up to you!
The key element of pricing is to keep experimenting. Some tactics will be more effective during different times of the year. And as you grow, you might find you can adjust your pricing to better increase your profit margins.
- Lena Klein