When it comes to setting the price of your goods, there are many factors you have to consider. This is how to actually set the price of a product.
To figure out the price of a product—commonly called the selling price—you should first look at what it costs you to sell the product to the client. This is called the cost price.
The cost price can include several costs, so let’s break it down.
This article is part of our pricing series
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Use the cost price to set the price of a product
The cost price is what it costs you to purchase or produce the goods that you sell.
We can divide all these costs into two categories: There are fixed costs that don’t vary depending on how many goods you sell. Examples of fixed costs include insurance and interest on loans.
Then there are variable costs that vary depending on how many goods you sell. Examples include the purchase of raw material and the labor costs.
Here are some common costs to take into account:
- The cost of purchasing the product
- If you produce the goods yourself, you also have to take into consideration those costs: such as the labor, raw materials, the purchase and maintenance of machinery and so on
- Warehouse costs, such as electricity and insurance
- Packaging
- The cost of promotional materials, if you for example include a discount flyer in the package. Doing this can help build great relationships with customers.
- Shipping and customs
To work out how much you’re spending in fixed costs per item, you have to work out the total fixed cost and divide it by the amount of goods you expect to sell. Then you’ll have to add the variable costs per item, for example the cost of packaging and shipping.
For example, let’s say you expect to sell 10 handmade rugs in a month. The fixed costs of running your business works out to $250 per month, for example insurance and warehouse costs.
You divide the fixed costs by the 10 rugs: 250/10 = $25. Then you spend $20 on raw material shipping and packaging per rug. That means your cost price per item is $45.
Once you know your cost price, you can at least make sure that you break even when you sell goods. But let’s not stop there.
See also: Download a free spreadsheet budgeting template
Consider how much profit you want
Next up, you should think about what kind of profit margin you want. The profit is what you’re left with after you subtract costs and taxes. The profit margin is a percentage that expresses how much you’re earning per sale.
If it costs you $50 to produce a product, and you sell it for $60, then you have a 20% profit margin. This means that for each dollar of sales, you’re earning $0.20 profit.
If, on the other hand, it costs you $58 to produce it, you’ll only earn a 3.45% profit margin.
Usually, businesses aim for at least a 10% profit margin.
If you’re planning to grow your business, for example by hiring more employees, conquering new markets or offering new products, you might want to aim for a higher profit margin. Of course it has to be within reason.
And that brings us to our next point.
Do your market research
Before you start your business, you should do some market research to figure out who your target customers are. This is part of making a good business plan. Once you know who they are, you should do some research into their key characteristics. You can find some information online, you can use a consulting agency, or you can do your own user research.
If you, for example, interview some potential customers, you can learn more about their habits and pain points, and also what they would be willing to pay for your product.
Pro-tip: It’s generally not a good idea to ask about price outright
If you ask a customer in an interview setting there are two reasons why they might just pull a number out of the hat:
- You’re asking a hypothetical question: ‘How much would you be willing to pay for our service?’. Hypothetical questions are hard to answer and the customer will likely just be making a guess. There’s no telling if they would actually pay that price if they were visiting your store, or going to your website.
- You’re in an interview setting and the customer might just say a high price to make you happy. This is a common impulse, we don’t want to create an awkward situation, right?
A better way to figure out what they would be willing to pay is to ask them about what they’re currently using instead of your product, and how much they paid for that. The second is to ask them about what kind of other products they’re paying for in their day-to-day life—or if they’re a B2B business, then as part of doing their business. That’ll give you a better idea of these customers’ willingness to pay and help you set the price of a product.
When you do market research, you should also look into your competitors. What are they charging? How is their product worse, or better, than yours? How do you want to position yourself, do you want to be a price leader, meaning you offer the cheapest product? If your product is demonstrably better than your competitors, you might be able to charge more.
In conclusion: How to set the price of a product
To round it all off, here’s what you need to know in order to set the price of a product:
- What it costs you to produce or purchase the product, including fixed and variable costs
- How much of a profit you want
- What kind of market your launching in, and how much your competitors are charging
Once you’ve collected all this information, you can set a price for your products. You might need to tweak the price at the start, or adapt different pricing strategies, to get a foothold in the market. Check out the ultimate guide to pricing strategies.
And don’t forget to reevaluate your price every so often, as prices tend to increase in general, and as your competitors adjust their strategies, and new competitors arrive.
Just make sure that at the end of the day, you’re earning above your break-even point and running a profitable business.
