Product pricing is an essential element in determining the success of your online business, yet eCommerce entrepreneurs and businesses often only consider pricing as an afterthought. They settle and use the first price that comes to mind, copy competitors, or (even worse) guess.
Humans are irrational. Product pricing strategy is just as much as an art form as it is a science.
Today, I’ll be breaking down the scientific side of how to price your product.
There are lots of resources out there on the art of pricing, but this step-by-step guide will provide you with the tools and strategies you need to create a reliable, data-backed pricing structure for your product.
There are lots of product-pricing strategies out there based on the study of human psychology.
Ending your price with a 9 or a 5, for example, is called “Charm Pricing.” Millions of businesses have used charm pricing to price their products, and it's proven to increase sales.
Or there’s “The Rule of 100,” a fantastic psychological hack to maximize the perceived magnitude of your discount, no matter the discount size. With The Rule of 100, businesses use percentage amount discounts for items under $100 and dollar amount discounts for items over $100.[*]
Without a doubt, psychology is an important part of pricing.
But let’s take a look at scientific approaches and strategies. Follow these steps to arrive at the optimal price for your product.
Thousands of entrepreneurs and decades of learning have paved the way for new businesses to craft a strategy that utilizes the most innovative pricing options available.
Knowing which pricing models work best in your industry can simplify how you price a product, and give you confidence knowing that you’re not simply guessing.
One of the most simple ways to price your product is called cost-plus pricing.[*]
Cost-based pricing involves calculating the total costs it takes to make your product, then adding a percentage markup to determine the final price.
For example, let’s say you’ve designed a product with the following costs:
Material costs = $20
Labor costs = $10
Overhead = $8
Total Costs = $38
You then add your markup percentage, let’s say 50% (retail industry standard), to the total costs to give you a final product price of $57.00 ($38 x 1.50). If you remember our “Charm Pricing” tactic from the beginning, you might mark this product at $57.99.
This method is simple, fast, and lets you quickly add a profit margin to any product you intend to sell.
Also referred to as a competition-based pricing strategy, market-oriented pricing compares similar products (competition) in the market.
The seller sets the price higher or lower than their competitors depending on how well their own product matches up.[*]
Price above market: Consciously pricing your product above the competition to brand yourself as having a higher-quality or better-performing item
Copy market: Selling your item at the same price as your competition to maximize profit while staying competitive
Price below market: Using data as a benchmark and consciously pricing a product below competitors, to lure customers into your store over theirs
Each of the above strategies in the market-oriented model has its pros and cons. With market-oriented pricing, it’s important to understand the costs of making your product, as well as the quality compared to competitors to accurately price your product.
Dynamic pricing, also referred to as demand pricing or time-based pricing, is a strategy in which businesses set flexible prices for a product or service based on current market demands.[*]
In other words, dynamic pricing is the act of changing a price multiple times throughout the day, week, or month to better match consumer purchasing habits.
Here’s how it might look for eCommerce businesses in action:
It’s not just services like Uber that take advantage of dynamic pricing to maximize profits. Amazon has long been using price surges on their most-competitive items for big eCommerce shopping days such as Black Friday and Cyber Monday.[*]
Amazon prices fluctuate so frequently that the price-tracking site camelcamelcamel checks prices for popular items several times per day.[*]
There are a ton of great software products out there that will help you to automatically apply dynamic pricing to your products, without breaking the bank or pulling your hair out.
Tool #1: Quicklizard
Tool #2: Omnia Retail
Tool #2: Profit Peak by Splitly (Amazon-Specific)
These tools allow you to set specific pricing guidelines by targeting certain margins that will help your eCommerce business to remain profitable.
If you are a commodity or service business, you can price dynamically based on usage. A usage-based billing method is popular among utility providers and is also catching up in the SaaS space.
Lots of businesses fall into the trap of thinking if they lower product prices, more people will buy the product and their revenue will increase.
“The problem with the race to the bottom is that you might win. Even worse, you might come in second.” — Seth Godin[*]
Strategically lowering product costs does have benefits, and can lead to increased revenue. For one, it reduces the amount of money being left on the table (consumer surplus) for customers who are willing to buy at various price points.
Put simply, Consumer Surplus is the difference between what the consumer pays and what he would have been willing to pay.[*]
So how do you maximize profits while also capturing more market share?
You need to understand the sales volume of a product at specific price points, and what allows you to remain profitable. In other words, you need to understand price elasticity.
Price Elasticity is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. If the quantity demanded of a product exhibits a large change in response to its price change, it is termed “elastic”.[*]
For a second, imagine you have 100 customers that purchase your product:
After testing pricing, you find customers convert at different rates depending on the price of the product. You also find that sales volume fluctuates with price:
Given this small amount of data, you can now easily calculate how much revenue is generated from each price point. Theoretically, this is a great way to improve upon the “base” product price that you calculated in step one:
But there’s one small problem…
What about the 65 customers that would have purchased at a $5 or $10 price point?
That’s $450 in revenue that you are losing out on. No sane business owner wants to do that, which is why you need a strategy to unlock that untapped gold mine.
There are lots of pricing strategies out there to do this, but my three favorites for profitably lowering prices are discount pricing, loss-leader pricing, and anchor pricing.
Discount pricing is a strategy where items are initially marked up artificially or start at a higher price, but are then offered for sale at what seems to be a reduced cost to the consumer.
An online retail store, such as Macy’s shown above, might offer discount pricing on all of its kitchen items for a limited time to attract new customers and boost sales.
This is a simple way to attract new customers that might not have bought a particular item at a higher price.
The key to ensuring that the discount pricing strategy remains profitable for your business is to keep the profit margins close to $0 or slightly positive. In other words, don’t sell your products at a discount just to get customers in the door, only to find out you’re losing money hand over fist.
Attract customers with discounts, keep your profit margin on discounted items close to $0, and then upsell or cross-sell other items in your store to turn a profit.
That is, unless you want to give loss-leader pricing a shot....
Similar to discount pricing in strategy, loss-leader pricing takes a slightly more risky approach to attracting purchasers.
According to Inc. “Loss-leader pricing is an aggressive pricing strategy in which a store sells selected goods below cost in order to attract customers who will, according to the loss-leader philosophy, make up for the losses on highlighted products with additional purchases of profitable goods.”[*]
Patagonia is a perfect example of loss-leader pricing done right. First, they start with a “Web Specials” page that they promote via email and social media:[*]
In examining their Web Special products, many items are sold at 25-75% below normal retail price:
The key difference with loss-leader pricing vs. standard discount pricing is businesses often know that they will not make a profit on items sold as loss-leaders. And that starts with a deep understanding of your product costs and profit margins.
Using this pricing strategy can help attract large numbers of customers who would otherwise shop elsewhere, and some of them will buy items with a higher profit margin.
There’s a great video of Steve Jobs announcing the iPad price on stage in 2010.
He rhetorically asks the attendees what they should price the iPad at.
“If you listen to the pundits, we’re going to price it at under $1000, which is code for $999,” says Jobs.
$999 appears on the screen before he continues…
“I am thrilled to announce to you that the iPad pricing starts not at $999, but at just $499.”
On the screen, the $999 price is shattered by a falling “$499.”
That’s anchor pricing at its absolute finest.
Anchor Pricing is where you display your “regular” price and then visibly lower the price of that item in stores or online. It works so well because it helps you to create an image in shoppers’ minds that they’re getting an incredible deal.
Little do they know that the regular price was made up in the first place!
At this point, you should have some idea of where you’re going to start with pricing your product.
But our work here isn’t done.
To ensure that you maintain long-term product profitability you must analyze your current business metrics, as well as design a plan to constantly experiment moving forward.
The pricing strategies covered above offer good guidance on how to price a product.
However, the mix of pricing strategies you implement must result in enough income to cover your overhead expenses, while also leaving you a bit of profit to spark continuous growth.
Overhead expenses that you should consider include:
Staff salary and related costs
Professional fees, licenses, or permits
Shipping supply costs
Website maintenance costs
I recommend calculating your overhead expenses on a monthly basis. That way you’ll have a running and accurate total at all times — allowing you to proactively price your product based on your findings.
If you find you’re operating at a month-over-month net loss, you can quickly make decisions to return to profitability.
There are many things that directly affect the pricing of a product. That’s why it’s important to not allow your pricing strategy to remain static.
Prices that fluctuate and move with the market will help to increase revenue and decrease consumer surplus.
Here are three great ways you can experiment with your pricing:
1. Raise Your Prices On Best-sellers
We’ve talked about how lowering product prices can lead to a reduction in consumer surplus, well raising your prices can have a similar positive effect.
If one or more of your products is selling at a high volume, experiment with raising its price. This will increase your gross revenue and allow you to make up for any other products that aren’t pulling their weight.
One way to offset the potential negative impacts of raising your prices is to experiment with pairing higher prices with free shipping. This will help to make your customers happy while also increasing your bottom line.
See below for more on “free shipping”.
2. Take Advantage Of Seasonal Discounts Or Promotions
Seasonal sales and promotions are one of the best ways to attract more customers to your website or physical store.
Even something as small as offering “free shipping” can help to increase customers and revenue.
According to First Round Review, Amazon famously drove up its purchase volume by offering free shipping for all orders over $25 (after an increase to $35 and back down to $25 in 2017). Free shipping is an attractive incentive because it appeals to anyone who is getting something mailed to them.[*]
3. Model, Don’t Copy Your Competitors
As with any great business or pricing strategy, looking towards the market (particularly your competitors) is a great way to stay on top of current pricing trends.
Everything from stock market fluctuations and employment rates, to new laws and trends, can affect the price that people are willing to pay for your product.
That’s why it’s important to keep an eye on the market and your competitors.
But remember, you are operating on your terms with your overhead expenses and profit margins. So while it’s great to evaluate how they’re pricing their product, you need to put your business first.
According to PWC’s “2018 Global Consumer Insights Survey,” global retail eCommerce sales will reach $4.878 trillion by 2021. That’s an 18% increase in worldwide eCommerce sales, from $1.845 trillion in 2016 to $4.878 trillion in 2021![*]
Millions of business are vying for customers’ attention.
One way to gain a competitive advantage in this wild marketplace is to have a product pricing strategy that is dynamic — one that moves with the market, and one that allows your business to remain profitable all at the same time.
The last thing you want is customers leaving your store because you fail to adapt, and update the value of your product.
Use this step-by-step guide constantly throughout the year. Save it to your bookmarks, add it to pocket, do whatever you have to do to keep yourself accountable for ensuring that your product pricing strategy remains competitive.