Pricing Guide: How to Price your Product
Pricing Guide: How to Price your Product
Where does a price come from? Well, there are many answers to that.
Some are rooted in logical analysis. Some seem to be plucked from the mist in a shaman’s sweat lodge because they just feel good.
Some work. Some don’t.
While it would be both futile and disrespectful to many an MBA to claim we can answer “what price is right?” once and for all in a single blog post, we will give you a few simple tools. These selected tools can have a big impact on “roughing in” something near the right prices as a starting point in many applications. A good dash of market testing and behavioral research can coax it to the sweet spot afterward.
*Disclaimer: It should be noted that these are not effective for commoditized products in efficient well-established markets. Since the crowd we roll with at CDN are more closely identified as “innovators” though (yeah – fist bump! ), you’ll likely find these useful.
How to Price your Product:
CDN Inc. is a product design and engineering firm that can adapt easily to your project needs; engineering, industrial design, prototyping & manufacturing.
Tool #1: Total Utility
With temperature-controlled cup holders, Bluetooth, air-ride suspension, 12” chrome rims and curb feelers, the GrassBlaster 3000 riding mower is too good to pass up!
Wish your mower had any of these features? How much would you pay for those cupholders?
Everything has value. Value can be defined as a ratio between the benefit or utility and the cost.
value = benefit/cost
Like the GrassBlaster 3000 though, most products don’t have just one singular benefit. When you break up products into individual attributes though, it’s a bit easier to assess the whole accurately. The total utility is the sum of all those individual benefits.
Total Utility = benefit + benefit + benefit + ….
Using our example, let’s say that there’s an established market value for a basic riding lawnmower of $5,000. But this isn’t just any lawnmower…
Where there’s a reference product or standard in the market already, it’s a reliable place to start. If not though, don’t worry. You can go through the same process by simply calculating the sum of all the benefits of your brand-new product. The total at the end is a good starting price to begin testing for market response and feedback.
You can see that this mower should be expected to cost about 70% more than the average. That’s a good premium. But does everyone really want the air ride suspension? Maybe after some polling, you find this would only appeal to about 10% of potential buyers. The value is high, but only for a small minority of buyers. In cases like this, it may be better to offer this feature as an option rather than standard equipment. Doing so would drop the standard equipment premium to just 55%. A big difference for the other 90% of buyers.
Breaking all the potential benefits of your product into individually assessed details like this can bring all sorts of insights. Make sure to pay attention to tangible benefits as well as the intangible emotional ones. Sometimes the latter can be tremendously impactful. Fair warning though: make sure it’s your potential buyers giving some assessments. We creators tend to fall in love with our creations a bit more heavily than others. The buyer’s opinion is the only one that counts here.
Tool #2: Volume Based Profit Analysis
For a price to “work”, it must be acceptable to both the buyer, in that they’re willing to pay for the perceived value, and acceptable to the seller in that it turns a profit. Sales volume is responsive to changes in price and costs are consequently impacted by sales volume. Since that’s the case, we can look at this mathematically to optimize an ideal offering price.
To do this, you’ll need to know your costs. Both your fixed costs and variable costs.
Fixed costs account for all the basics that allow your business to exist like your building, fixed salaries, utilities, property taxes, etc. Variable costs are those associated with each unit produced. This includes the purchased parts and raw materials used to make each unit, labor costs for each unit, incremental utility and supplies costs for each unit, etc. The total variable costs go up as the volume produced goes up. The total fixed costs remain the same. They are independent of volume.
Let’s use round numbers of an example product that sells for $100. The fixed costs for current production volume of 1000 units is $2,000 ($20/unit). The variable cost for each unit is $40/unit. The minimum price is $60. There is no profit at this price and a loss for any price below that.
To change a price from the current level, the chart shows the offset in volume needed to retain the same contribution profit margin (currently at 60%). In this example, it means that offering a discount promotion of 10% off the regular price requires that volume increases by 20% to get the same bottom
line profit compared to doing nothing. If a 10% discount brings a greater increase in volume, you win. If a 10% discount brings in any less than 200 more sales than before, you lose.
Likewise, you can decide to raise the price by 15%. As long as the sales volume doesn’t drop more than 20%, you win. If you only sell 810 units instead of 1,000 units, you will actually generate more profit than leaving the price the same.
What if an opportunity comes in for a BIG volume contract at a steep discount? This tool can be used to evaluate whether it’s advantageous to the bottom line to take it. No stress.
To see how this works with your products, download the spreadsheet through the link below. You can put in your own numbers and see how price, volume, and profit margins are related and use it to make decisions on promotions and those big juicy contracts that come your way.
If you’re more the geeky type like us and want build your own, here are the equations involved.