Pricing your products and services isn’t always easy — but the right prices are key to profitability and success. There are multiple factors to consider, including cost, value, and the type of industry you’re in. Learn how each of these impacts your business so you can make smarter choices about price. Use these five tips as a jumping-off point.

1. Consider the different types of pricing

Which method you use may depend on the kind of business you operate.

  • Cost-based: The selling price is determined by the cost to make a product (including materials and labor) plus a markup. 
  • Value-based: The selling price is determined based on perceived value. For instance, if you sell luxury items, the value of your goods may be linked to more than just the underlying costs.
  • Competitive pricing: The selling price depends on what competitors charge. This includes penetration pricing, where you set your prices below competitors to gain market share, then increase them to a more sustainable level.

  Tip  

To determine which type of pricing to use, consider your specific business and goals, as well as your target customer. If you’re pursuing a luxury audience, for instance, value-based pricing may make sense, whereas competitive pricing may be crucial if you’re targeting cost-conscious customers.

2. Determine your costs

Even if you decide to use value or competitive pricing, you’ll still want to be aware of cost-based prices for your product, simply because charging more than you spend is the basis of profitability.

Determining cost depends on your business. If you buy products and resell them, this is simply the cost you pay, plus any labor or costs involved in the resale. If you make your own products, you’ll need to consider the cost of all materials, plus the hours and labor involved in production. Be sure to consider shipping and any marketing expenses needed to sell merchandise.

The tally for all of these is known in accounting as costs of goods sold (COGS).

If you offer a service, versus a product, be sure to note any per-service costs. For example, a photographer renting studio space would need to price in per-session costs, whereas a studio owner would not.

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To calculate labor costs, note hours of labor involved, then the per-hour cost. This allows you to adjust your calculations as your business evolves — like if you learn how to make a product quicker or give your employee a raise.

3. Evaluate your margins and profitability

To track how profitable your business is, look at the following:

  • Overhead refers to expenses that aren’t directly tied to making products. It can include fixed costs, like rent, as well as variable costs, like machine repair.
  • Margins are the price you charge a customer less the cost of goods sold (which you determined in step two).
  • Profitability , or how profitable you are, depends on these numbers. See how many items you need to sell for your margin to equal your overhead. This is your breakeven number . Once you top this, your business is profitable.

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Take your time on this step and consider different variables. If the number of units you’d need to sell doesn’t seem doable, you may need to adjust your pricing. Remember that miscalculations here can lead to losses.

4. How much are people willing to pay?

If you’re selling directly to customers, your pricing formulas are straightforward: the price you set is the price your customers pay.

Selling via third parties can be more complicated. Sites like Facebook or Etsy take a commission, so you may need to raise prices to account for that.

Selling to retailers can help you sell more products, but you’ll need to use wholesale pricing. Expect retailers to double whatever they pay you when selling to the end customers.

If you don’t think customers will pay double your wholesale price, you have two options. First, you can lower your wholesale price. If you can’t lower your wholesale price, consider a manufacturer suggested retail price (MSRP). Retailers don’t have to use this, but it may help them better understand the market for your products.

5. Scope out the competition and marketplace

If you’re opening a coffee shop in an area that has no other coffee shops, you may have more flexibility with your prices than if you’re opening a coffee shop in a neighborhood with several. (If the latter, think back to the competitive or penetration pricing discussed in the first tip, in addition to cost-based pricing.)

This competitive intelligence tool (sponsored by Wells Fargo) can help you do a competitive analysis to inform your pricing .

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If you’re going with prices that are higher than the competitors’, be sure to think through how your products and services are different, then market them accordingly. This helps potential customers understand the value behind the price tag.

You may need to test and adapt your pricing before you land on a final number. If you’re unsure of how to price a new product or service, ask a trusted customer. If you’re just starting out, seek the advice of your network or a trusted mentor, in addition to performing the steps listed here.

Sources: the balance small business, Houston Chronicle, Shopify

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