Product Pricing: Choosing a Pricing Method
- [Sarah] For most consumers, price can be a determining factor for whether or not they purchase a product.
This is particularly true for products that could be classified as wants rather than needs.
The person pricing your products must consider many factors, such as cost of production, financial goals, and consumer demographics.
This video will cover five pricing methods that can be used.
Pricing methods should be chosen with your business goals in mind to ensure that they not only align with but move you toward achieving those goals.
It is important that you perform market research prior to determining the prices you will assign to your products or services.
Your business and marketing goals, knowledge of the industry, your competition and the market are essential.
It is also essential that you calculate the cost of producing the product or providing your service by completing an enterprise budget.
Make sure you have accounted for all fixed and variable costs.
The cost of production for a product will provide you with a base or breakeven price.
Once you know your cost of production, you should run sensitivity analyses.
This will show you what your breakeven price would need to be if there are changes either in the price of your inputs or to the amount you are able to produce.
The first pricing method we'll cover is cost-plus pricing.
Cost-plus pricing is a method whereby the price for a product is determined by first determining the cost to produce the product and then adding on a standard markup.
Let's go through an example to illustrate.
Assume that you make apple butter and the cost to produce it is $1.75 per jar.
Assuming that you apply a standard markup of 60% to all your products, the markup would be $1.05.
Adding those two values, $1.75 plus $1.05, gives you the final sale price of $2.80 per jar.
Target return pricing is our next pricing method.
This method sets prices in such a way as to generate a target return on investment.
As an example, assume that you have invested $100,000 into the production and marketing for your new maple syrup product and that you have forecast that you will be able to sell 50,000 units.
Cost of production for each unit of the product is calculated to be $2.25 for a total production cost of $112,500.
Finally, you decide that you want a target return on investment of 30%, or $30,000.
Continuing with our example, we add our total cost of production and our target return values together to arrive at the gross revenue value.
In this example, gross revenue must be $142,500 to achieve the $30,000 return on investment.
Finally, we divide the gross revenue figure by the quantity that will be produced.
This results in a sale price of $2.85 per unit.
A value-based pricing method determines prices based on the value that consumers place on and their willingness to pay for the product in question as compared to other alternative products available to them.
Utilizing this pricing method can be difficult, since it is necessary to assess the value that your customers place on the product.
However, let's assume that you produce a fine sheep's milk cheese and comments made by a test group of customers leads you to believe that they think your cheese is of higher quality and better taste than comparable cheeses available at area specialty stores.
Using this information, you would price your cheese higher than these other cheeses, being sure to cover your costs of production.
Our fourth pricing method is psychological pricing.
This pricing method takes advantage of consumers' perceptions when they see product prices.
For instance, pricing a product at $0.97 rather than at an even dollar amount takes advantage of the perception that $0.97 is a deal.
Let's say that you have produced apple cinnamon tarts with a cost of production of $1 each.
Typically, you utilize a cost-plus pricing method where your standard markup is 100%.
Pricing this way with the tarts would result in a price of $2 per tart.
However, understanding consumer perceptions of prices, you decide to forego your standard pricing method and instead utilize the psychological pricing method with the tarts, pricing them at $1.97 each.
The $1.97 price will appeal to the customers' perceptions that they are getting a deal, since they are paying less than $2.
The last pricing method we'll cover is subscription pricing.
Subscription pricing is something that most of us are familiar with.
Magazines and newspapers employ this pricing method.
There are two versions of subscription pricing that can be utilized.
With one version, the customer is charged an initial price for the purchase of the product or service and then charged an additional fee on a regular schedule, annually, monthly, et cetera, for continued use of the product or service or for upgrades to the product.
Another version of this pricing method would have the customer charged on a regular schedule but without an initial fee.
Either type of pricing would work well for agricultural services such as custom work, community supported agriculture or CSA shares, or if you wanted to provide products to your customers on a regular basis, for instance as with a Jams of the Month club.
Pricing, while a vital function and a critical component to the success of your business, does not need to be overly complicated.
Knowing the cost to produce or provide your product or service is the first and most important piece.
Never price below your cost of production.
After determining your cost of production, you can choose the pricing method that best fits your business and management style.
Finally, your target customer and product characteristics need to be considered when choosing a pricing method.
For example, utilizing value-based pricing when your target customer has a fixed income likely will not be successful.