Product Pricing is one of the 4 cornerstones of marketing (4P's - Product, Place, Price, Promotion), and when it comes to selling products, decisions are being made by both the store owner as well as the customer - sticking to the right balance can maximize your conversion, all the while optimizing your profitability. Small businesses have the toughest time setting the right price in their Shopify store, given the reach of customer sensitivity is harder, and potential customers have limited feedback. The impact can be up to 20-50% of profits when tuning your pricing for an online business. Your online store will require a pricing strategy considering costs, price sensitivity, competition, and supply/demand dynamics with seasonality considerations.
Product Pricing definition
It is the set value placed on a product based on internal costs of acquisition, logistics, and fees/taxes vs. the external value that's placed on the product based on demand, utility/function, and core set needs of individuals (luxury vs. base necessity). Pricing has an inherent impact on your business finances - total revenue, margin, net profit.
How to approach product pricing
There are several approaches to Product Pricing - some are more complex than others, and some require market inputs that you may or may not have the reach. Let's explore some below:
Cost Plus Pricing - Without external input, you can add up all your costs on a particular product, including all logistics, packaging, storage, rent, taxes, and overhead - add your Margin %, and you get a number. However, this product price may be over what the market can bear, or below it - but it is a start.
Market Pricing - This requires a study of the market when it comes to competitive pricing, and how the market promotes the item in various seasonal situations. Take a PC with a specific configuration, discounts may appear during Black Friday, Christmas and Back to School times, with a drop in price of 15% on average, with 20% on Black Friday. Volumes of PCs throughout the year need to be obtained to allocate price so as to ascertain the average price for the year. With competitive pricing vs. your Cost Plus Pricing you end up with gaps where competition might be higher, or you might end up higher than the competition. What is important to note, is the customer doesn't consider your costs but looks at the competition. Unless you have added value to offer such as a longer warranty, they will unlikely choose your product over the competition if your price is higher. Thus competitive pricing is a key ingredient in your Pricing and should keep your competitive matrix updated regularly throughout the year.
Variable costs of a product
If the raw materials are purchased in bulk, you will have to amortize the cost of storage and logistics over the number of units. Bulk buying will have its own variable price (the more you buy, the better the price). The best approach is to look at it on average when in the acquisition position. When in the building and creating/making a product, then the cost of labor, insurance, training (if applicable), and the various miscellaneous associated costs in creating a product. This then becomes your base product and can be then taken as an inbound product which then has storage, packaging, insurance, etc. Variable costs are based on the changes incurred in product availability for a client to purchase. Understanding the variations, and applying them to market dynamics (In-season products may have a lower price than off-season products as an example due to sourcing/logistics/storage). Online shops can easily adjust pricing for these situations.
Setting your profit margin
Keep in mind that your overhead/fixed costs need to fit within your profit margin, and when deducted you end up with your net margin. Understanding your costs well gives you two key tools - you can extrapolate on the competition's costs of the same product, as well as you can drive cost reduction activities in the various departments to improve your net margin. Your target audience will review your product attributes and value vs. the competition - they will understand your marketing value proposition, differentiation, and promotion. When selling products online, this becomes an easy exercise for the buyer for most types of products. Depending on the point of sale (POS) - online+delivery, Pick-up or In-store price for the customer might vary since Shipping might be involved while picking it up at the store would be at a minimal cost. Your profit margin gets squeezed between your competition and the value/brand equity/warranty you might bring to the customer and how they value the overall purchase.
Pricing is not the only Conversion factor
They say "Price is King", which in many ways it is true. However there are caveats to this mantra - it is true if the package gets to you reliably, if it gets to you on time, if the product is as reliable as the others, performs like the others, or has the same experience as the others. To do a good job of your pricing, getting your hands on the competitive products can be an amazing knowledge trove on how to price things. Using the competitive products and understanding all its nuances, features down to weight and size on how it is applied, work with procurement on the base costs and stack them up. Only then when a full evaluation is made, you can do a good comparison of your product and market price. Doing a comparative matrix on a competitive breakdown will give you the best information on how your brand stacks up, what value your customers place on your products based on pricing (if higher), and how your service/customer satisfaction drives your sales.
Your fixed costs need to be spread across all your sales - obviously. Rent, taxes, and if you have stable must-have costs such as electricity, salaries, gas, and other utilities which will be constant to operate. This overhead will come to a number over a year, and when calculating your overall sales in volume, and having your gross profits added up - this overhead needs to be subtracted. In an ideal world, the total after that subtraction will leave you with a net profit number. Managing your fixed costs to be competitively low can be difficult and depends much on your negotiating skills.
In most cases, a business plan of some form was produced and followed. However, it is not unusual to have products deviate from the main plan. Yet, all products must be priced and done so with care. Applying intelligence to product pricing takes time, money, and organization. If you go as far as competitive tear-downs then you will get the most intelligence possible, which a lot of large companies do. It is part of your SWOT (Strength Weakness Opportunities and Threats) Matrix, which would be in your business plan. Large business manages their fixed costs through business improvement efforts and has the resources to optimize their profits. Small Businesses usually don't have the luxury of market studies and purchase quantitative or qualitative studies to better ascertain the competitive landscape - but can purchase competing products and do a decent job of a competitive cost stack-up. Using your competition is important in sizing demand, price sensitivity, seasonality, and overall user experience.