Product pricing is essentially the process of determining the cost of products you sell to consumers. When you are figuring out how to price a product for retail, you are facing a delicate balance—price your items too high, and no one will buy; price them too low, and you sacrifice your profits. This article provides a five-step guide on how to price products, from determining your costs to making adjustments and embracing the pricing fluidity that will maximize your profits.
Step 1: Determine Your Costs
Before you can begin pricing retail products, you have to understand all the costs associated with buying and selling them, as well as other costs associated with running your business. This will give you an idea of the expenses that your sales have to cover. In other words, how much money will your product sales need to generate?
In general, retail costs fall under two categories—cost of goods sold (COGS) and fixed costs.
Step 2: Consider Your Market
Along with accounting for product and business costs when pricing retail products, you will also need to take two other variables into consideration: your target market and your competition.
A key part of successfully pricing a product is ensuring the price will be feasible for your target market. Your target market is the group of consumers—defined by age, gender, socioeconomic position, location, etc.—to which your products and marketing are aimed.
You want to understand who your target market is so you can understand their preferences and behaviors.
For example, if I defined my target market for my organic pet food store, the group could be middle-aged or young pet owners who have some extra spending money to buy higher-end pet products. Location-wise, my target market is in the upscale community around my store.
Once you have defined your target market, you will then consider them as you make pricing decisions. This will largely come down to their spending power and their demand for your product.
In addition to your target market, you will also need to understand the larger market you are competing against so you can price your product competitively.
Take a look at retailers that are already selling your products or similar products. See how they are pricing their items, take notes from the most successful brands, and seek to define a niche that is adjacent but not the same.
Related: Read more with our guide to finding a niche market.
For example, if I research organic dog food brands online, I see that the typical selling price is anywhere from $65–$120 for a bag. The biggest names in the organic pet food space sell their bags for $85–$105.
Step 3: Choose a Pricing Strategy
Once you have a grasp on your outgoing expenses as well as the market you are selling in, it is time to get into the weeds and start actually pricing your products.
To start, select a pricing strategy. Pricing strategies create a uniform approach to pricing retail products and help ensure that your prices are fair, consistent, and profitable.
When selecting a pricing strategy, take into account the idiosyncrasies of your specific situation and adjust your pricing strategy accordingly.
- Industry standards (ensuring that your prices are competitive)
- Legal regulations (are there prices or ranges you must adhere to?)
- Net and gross margins
- Local purchasing power
- Product costs
- Overhead costs
- Brand positioning (luxury, bargain, etc.)
Continuing with the dog food example, if my target market is located in a more upscale community and willing to spend a little extra on their pets, I might shoot to price my product somewhere between $80–$100 per bag. (Remember that our competitor research found pricing ranging from $65–$120.) However, a similar store that sells organic dog food in a middle-class neighborhood might price at the lower end of the range, around $65.
Because of the different locational factors affecting these stores, both will likely be able to sell their dog food with similar success. Not only that but because the two stores’ fixed costs are likely different, they will probably result in similar net profits.
If you want to learn more about the different pricing strategies at your disposal, their industry uses, and how you can implement them into your business, check out our breakdown of pricing strategies.
Step 4: Calculate Potential Profits
After setting prices for your products, it’s time to determine the next variable: your profit. In retail, your profit is expressed as your gross margin and your net margin. Take a look at both below, and use our margin and markup calculators to determine your profits.
Gross Profit Margin
Your gross profit margin is the amount by which the selling price of an item exceeds its COGS, expressed as a percent. It is a great gauge to see if your prices fall in a reasonable range and will give you a better idea of your pricing’s consistency as wholesale or manufacturing costs change.
Use the calculator below to determine your gross profit margin.
If you would rather calculate your gross profit margin by hand, you can use the formula below.
Gross Profit Margin = (price – COGS)/price
Taking an example, at my boutique, we would buy tank tops for $7 and then sell them for $14. The gross profit margin of these tanks was:
Gross Profit Margin = ($14 – $7)/$14
Gross Profit Margin = $7/$14
Gross Profit Margin = 0.5 (50%)
According to ongoing research from NYU’s Stern School of Business, the average gross profit margin in retail is 23.25%.
Net Profit Margin
Your net profit margin, on the other hand, is a measure of your profit as a percentage of your revenue. Essentially, your net profit margin tells you your total profitability, taking into account both COGS and fixed variables. You can use net profit margin to gauge your company’s bottom line.
If you don’t want to do the math by hand, you can use the net profit margin calculator below.
You can also calculate your net profit margin using the formula below.
Net Profit Margin = [total sales revenue – (COGS + fixed costs)]/total sales revenue
Taking an example, let’s say my boutique has a sales revenue of $36,000 for the month. Each month, fixed costs are $13,000, and the COGS for the items sold was $19,000.
Net Profit Margin = ($36,000 – ($19,000 + $13,000))/$36,000
Net Profit Margin = ($36,000 – $32,000)/$36,000
Net Profit Margin = $4,000/$36,000
Net Profit Margin = 0.11 (11%)
According to ongoing research from NYU’s Stern School of Business, the current average net profit margin for retail is 2.35%
Step 5: Monitor & Adjust
One metric you will want to track as you explore different pricing strategies is price elasticity of demand, which looks at the change in consumption of a product in relation to a change in its price. In other words, price elasticity of demand measures how a change in price affects how well a product sells.
Expressed mathematically, price elasticity of demand looks like:
Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price
Note: A negative value does not impact or change the price elasticity of demand (PED) percentage. In other words, 1.2 and -1.2 mean the same thing.
Based on its price elasticity of demand, a good is either elastic or inelastic, and we will look at what that means below.
Promotional Pricing Tips
As you review the effectiveness of your pricing strategy, a tactic you might try with items that are not performing well is putting them on a promotion. While this might help move unsold products in the short term, promotions do sacrifice your margins and can eat away at your profits if not applied properly.
Before discounting, try the following:
- Market the product on social media
- Improve how the product is merchandised in your store and online
- Be sure the item is available on your ecommerce site
- Coach your staff to recommend the item
- Promote the product via an influencer
- Put the product in front of new audiences/markets
If you try these strategies and the product is still not having success, then a sale or promotion might be the best move. You should be sure that you know how the sale will impact your profits before you start and then seek to end the promotion before cutting into your bottom line.
How to Price a Product Frequently Asked Questions (FAQs)
Click through the questions below to get answers to some of your most frequently asked product pricing questions.
A good selling price for a $50 item depends on a few things, including your fixed and inventory costs as well as your target market and your competition. In general, however, retailers sell their products with a 15%–60% markup or $57.50–$80, in this case.
Product profits vary based on your costs, but if you are only looking at the difference between purchase and selling price, your profit should be 15%–60% of the purchase price. If you purchased an item for $10, you should sell it for $11.50–$16 and make between $1.50–$6.
Price a product to make a profit by considering your costs, customers, and competition so that the price both covers your expenses and is sellable.
The pricing process for handmade items is similar to regular items. As with non-artisanal products, consider costs, customers, and competition. From there, you should also account for time and labor and the added value of the item being homemade. This is a great place to take cues from competitors or similar vendors.
How to price products is a big question that retailers have to answer accurately to run their business well. When you price your product effectively, you stand to both make sales and a good, sustainable profit that will keep your business running and growing. When you overprice or underprice items, however, you stand to lose money or incur high holding costs. With the tools in this guide, you will be able to create a pricing strategy that will drive sales and help your business thrive.