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What is Product Pricing?

GoCardless
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Last editedMar 20233 min read

The importance of product pricing is recognised by all successful businesses. Understanding how to price a product effectively can make a huge difference to a company’s bottom line. With that in mind, here is a quick guide on what you need to know about product pricing.

What is product pricing?

Product pricing is the process of choosing the appropriate price for a product. Some product pricing methods are purely quantitative. This means they only look at objective factors, such as cost. Many product pricing methods do, however, have a qualitative element. For example, one that may reflect the overall prestige of a brand.

What are the factors to consider when pricing a product?

There are five key factors you should consider when deciding how to price a product. These are outlined below.

Costs

In principle, you can price a product lower than its production cost. This is sometimes done for strategic reasons. Most of the time, however, cost is a very important consideration in product pricing.

Demand

If demand for your product is high then you might want to make hay while the sun shines. In other words, price your product as high as the market will support. You can always reduce it later if demand slows. 

It’s also very helpful to know your overall market trajectory. For example, do you expect demand to be flat, increase steadily or have peaks and dips?

Customer purchasing power

You need to know how much your customers are reasonably able to pay. Ideally, you should also know how much they are willing to pay.

Brand perception

How do customers view you both in isolation and compared to other options?  Could your brand perception be improved?  If so, how can it be improved and how long will it take before the improvement process delivers real benefits?

Goals

Generally, businesses have one of three product pricing goals. These are:

Cover costs

There are two main reasons why businesses might only aim to cover their costs. The first is that they’re testing the waters with a new product. If the test is successful, the product pricing will be reviewed. 

The second is that a business is experiencing what it expects to be temporary difficulties. These may well be due to factors outside its control, such as the broader economy. In these situations, a business may just batten down the hatches and aim to weather the storm. Once the situation has improved, it can review its product pricing.

Maximise sales

Again, there are two scenarios which may lead businesses to focus on maximising sales. The first is when a startup moves into its growth stage. The second is when an established business launches a new product or service. 

In both cases, the businesses might be willing to leave some profit on the table with each sale to gain market share. This is particularly likely if the business is a startup or is moving into a new market. In these cases, businesses cannot leverage previous success to impress potential customers.

Maximise profits

This speaks for itself. Indeed, it’s the end goal of most businesses.

How to price a product

There are five main product pricing strategies currently in use. They can be used individually or in combination. Businesses can also switch between them as circumstances change.

Cost-plus pricing

This is the simplest product pricing model. The business takes the unit cost per product and adds its desired profit margin. 

Cost-plus pricing does have its uses. For example, if you have a rapid product turnover, cost-plus pricing may be your only practical option as you will not have time to do the research needed for some of the other product pricing strategies. 

In general, however, cost-plus pricing is regarded as a fairly clumsy product pricing model. It rarely maximises a business’ opportunities for profit.

Penetration pricing

Penetration pricing is when the business deliberately prices a product below its usual sales price to increase sales. This is usually done with a view to expanding market share or expanding into new markets. 

Penetration pricing often follows the cost-plus product pricing model. The key difference is that penetration pricing is always intended to be temporary.

Competitor-based pricing

As its name suggests, competitor-based pricing requires you to benchmark your standing in the market against your competitors. You then reflect this in your product pricing. For example, if you discover that you are perceived as a mid-range brand, then you set your product prices in the middle of the standard range.

Dynamic pricing

In principle, there are two ways you can implement dynamic pricing. These are according to demographics and according to demand. In practice, implementing dynamic pricing based on demographics is likely to be way too risky to be worth considering. Even if you can do it legally, you may face consumer backlash.

By contrast, implementing dynamic pricing based on the level of demand is fairly commonplace. It’s often referred to as surge pricing. With that said, it’s still important to stay aware of consumer perception. If the difference between the peak price and the trough price is too large, consumers may feel that they are being exploited.

Value-based pricing

The essence of value-based pricing is to base your prices on your customers’ ability and willingness to pay. In the case of product pricing, this is often translated into a product pricing model known as price skimming.

Price skimming is when a product is given a high price at its initial launch. This price is then reduced over time. Both the technology and the fashion sectors routinely use this product pricing model.

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