There are probably a bazillion ways to price a product, but I am going to stick to the most traditional, simplest process. So, let’s start by assuming you know there is a market need, what competitors are charging for a similar customer solution, and how much they’re willing to spend. When you develop your product price using the 5 Steps, do a sanity check based on the current market and competition.
The example I always like to use is “burgers and fries”. If you are going to sell “burgers and fries” like McDonalds, your price needs to be close to McDonalds’ price. But if you are going to sell Kobe beef hand-formed patty on a homemade bun with a side of french fried plantains in a full service restaurant, with a bar and floor show, you can charge more for your “burger and fries” and purchasers will feel good about their buying decision. So, as you read the 5 Steps below, including REMEMBER!, keep this analogy in mind.
Step 1: Calculate cost of goods
These should include only the costs DIRECTLY associated with making and selling the product, like parts and labor. These should not include indirect or overhead costs that you would have to pay, whether or not you made a product, like rent, utilities, etc.
Step 2: Determine your revenue requirements
The amount of money you need to make to cover the Cost of Goods and all your indirect and overhead expenses and make your desired profit level.
Step 3: Evaluate your pricing strategy
The typical strategies are HIGH, LOW, or PARITY, based on what the competition is currently selling their product for. HIGH is good if you can deliver more value and differentiation, LOW is good if you are new to the market, but will make it difficult for you to raise prices later. PARITY is good when there is little differentiation between you and the competition.
Step 4: Decide on pricing policies
Consider policies like offering volume discounts; including shipping costs in the price; offering warranties/maintenance contracts as add-ons or including these in the price; bundling products and services. You still recover your cost of goods and overhead, but the purchaser perceives they got a great deal! See REMEMBER! below.
Step 5: Analyze potential net revenues
There are two basic methods: Cost-plus pricing and Marketplace pricing
Cost-plus: Total costs (COG + Overhead) X Desired profit (e.g., 20% on all sales) = Required sales price
Marketplace pricing: Market price (the limit they are willing to pay) – Total costs = Obtainable Profit Level
Based on your sales forecast and your projected price for both methods, calculate the total revenues and profits. Will you make enough revenue to meet all your expenses and your desired profit?
REMEMBER! – The marketplace will ultimately set the price. So once you have landed on what you believe to be a good price, test it with potential customers and compare to your competition. And don’t forget about the “5 F’s” I discussed in The Must knows of marketing: Back to the basics. People buy on an emotional level; their decision to purchase needs to make them feel good.