This article is part of a larger series on Retail Management.
Deciding how to price a product can mean the difference between success and failure for your small business. Price your items too high, and no one will buy. Price them too low, and you’ll struggle or even lose money. Pricing strategies are a mix of art and science, and you will likely have to play with different strategies and adjust your methods frequently.
In this article, we will walk through which metrics you should be paying attention to when devising a product pricing strategy, the different strategies you can use, and where they are best suited, as well as how you can measure the success of your pricing and adjust as needed.
1. Know the Metrics
Before you begin creating a pricing strategy, you should know the different metrics that pricing strategies use. Using these metrics will help you understand your profitability, product value, and how supply and demand can impact the price of your goods.
Here we will go over profit margin, markup, and price elasticity of demand, as well as what they mean and the equations you can use to calculate them.
For companies that sell a large number of items, you might find it helpful to use an integrated point-of-sale (POS) system like Lightspeed to track this automatically. Lightspeed allows you to set up your inventory, add modifiers for things such as size or color, apply markups or discounts, and track metrics all in one system.
Your profit margin, also known as your net profit ratio, measures the amount by which revenue surpasses costs to your business. In other words, your profit margin is how much you get to pocket after you deduct the wholesale and overhead expenses from the item.
Take the example below:
100 or 50%
In this example, you have a product that sells for $200, which you purchased for $100. So, when you deduct the cost of the product ($100) from the sale price ($200), you are left with a $100 profit. This $100 profit is 50% of the sale price ($200), so your profit margin is 50% ($100 profit/$200 sales price).
If you always double your product cost to get your selling price, you’ll always have a 50% profit margin. But that’s rarely feasible, so here’s the math you’ll use to figure your profit margin for other markups:
(Selling Price – Cost) ÷ Selling Price = Profit Margin
In another example, let’s say you purchased an item for $70 and sell it for $130. In this case, your profit margin would be about 46%.
($130 – $70) ÷ $130 = .4615
The next metric that you frequently use when assessing product pricing is your markup. Markup measures the amount you add to your product cost to get to your selling price. Unlike your profit margin, your markup is not a measure of your profitability, but rather a measure of how much you are increasing the price of your product.
$100 or 100% markup
In this case, you have a product that sells for $200, which you purchased for $100, so the markup is $100 or 100% of the initial product cost.
If you double your product cost, your markup will always be 100%. There are times when you will need to markup by more irregular numbers, however, and in that case, you would use the following equation:
Cost + (Cost x Markup Percent) = Selling Price
Let’s take another example. Say you purchase an item for $30 and you want its markup to be 140%. In this case your selling price would be $72.
$30 + ($30 * 1.4) = $72
Tip: Your markup can be anywhere from 1% to 1000%. It all depends on what customers are willing to pay and the type of good you are pricing. To maximize your profits, play with different margins to maximize how much you can successfully charge.
On a daily basis, markup calculations are what most small businesses, especially retailers, use to price products. I would recommend using markup as your starting point for product pricing and continuously monitoring your profit margin to look for large profit trends. You can also use our gross margin and markup calculators for faster outputs.
Price elasticity of demand 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. You should monitor your price elasticity of demand to give you an idea of how you should be pricing your products to maximize their sales and your profit.
Expressed mathematically, price elasticity of demand looks like:
% Change in Quantity Demanded / % Change in Price = Price Elasticity of Demand
Let’s take an example. Say you change the price of your best-selling top from $40 to $30 (-25%) for the summer. Because your product has become popular and the demand is high, you sell 30% more shirts. In this case, the price elasticity of demand for your bestselling shirt is 1.2%.
.3 / -.25 = -1.2*
*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 their price elasticity of demand, a good is either elastic or inelastic, and we will look at what that means.
For some products, demand is inelastic. Things like gasoline or bread have inelastic demand because people are willing to pay for them no matter the price. Typically, necessities like essential food products, utilities, and transportation have inelastic demand. Brands with great recognition, like Apple or luxury brands, also tend to be inelastic.
Inelastic demand: Demand for a product is unaffected by a change in price.
For a good to have inelastic demand, the demand should change by less than the price changes, making the price elasticity of demand less than one. For example, if the price of apples changes by 10% but your demand only decreases by 5%, then your price elasticity of demand would 0.5, making apples inelastic.
The majority of goods and services, however, have elastic demand. Customers typically decrease their demand as the price of a good goes up and increase their demand as the price of a good goes down.
Elastic demand: Demand for a product changes based on the price of the product.
For a good to have elastic demand, the demand should change by more than the price. For example, say the price of apples increases by 8%, so consumers decrease their purchase of apples by 19%. In this case, apples would have a price elasticity of demand of 2.375, making them quite elastic.
The goal of any business is to create an inelastic demand or a willingness among your customers to pay any price for the goods you sell. One of the best ways to do this is by creating exclusivity or a sense that your product is unique and limited in quantity. This supposed rareness will incite a sense of urgency among your customers and a willingness to pay more for the good.
For example, at my boutique, we sold a popular Denver hat that many boutiques in the area also carried in their stores. To set ourselves apart, we worked with the company to get the hat in an exclusive color, sold only at our stores. We were able to mark this hat up by 25% and still sell out of them in record time because of its exclusivity and limited supply.
2. Choose a Strategy: 18 Pricing Strategies
Knowing which pricing strategies apply to your industry can simplify how you price a product, minimize the math you need to do, and give you a window into your competitors’ pricing strategies. Here are 18 commonly used pricing strategies and the types of businesses that use them the most.
Tip: Most businesses find that a mix of a few different pricing strategies works best to bring in customers, encourage sales, and yield a profit. Use the pricing strategy that makes sense for your products and business.
Commonly Used By: Retailers and Ecommerce Retailers
Keystone Pricing: A standard 100% markup, or doubling a product’s wholesale cost, to get the selling price.
Keystone Pricing Math: Cost x 2 = Selling Price
Keystone pricing is the retail pricing rule-of-thumb and also extends to retail ecommerce. Keystone is a simple pricing strategy to apply, but you need to ensure that your keystone profits will cover your basic operating costs, which we go over below.
Generally, retailers and ecommerce sellers use keystone pricing as a base markup on most goods, then apply higher markups or discounted pricing to certain items based on demand, volume, and competition.
Manufacturer’s Suggested Retail Price (MSRP)
Commonly Used By: Retailers and Ecommerce Retailers
MSRP: The price the product manufacturers set for their goods.
The MSRP pricing strategy is another popular pricing for retailers. You’ll find that the MSRP price comes from the Keystone pricing strategy covered above for most goods. But, retailers usually drop the MSRP selling price by 1-5 cents due to Psychological Pricing, which we’ll discuss next.
Here are common MSRP examples that you’ll find on manufacturer and wholesaler price lists:
Your Wholesale Cost
The downside of using MSRP as your pricing strategy is that you’ll have the same prices as your competitors. So, you’ll have to differentiate your store in other ways, such as free shipping for ecommerce sellers and exceptional in-store promotions for retailers.
Another thing to be aware of is that some suppliers actually insist that you use their MSRP to preserve the value of their goods and brand. They will even force adherence by refusing to fill stock orders for stores selling under MSRP. This is something to keep in mind when dealing with suppliers, especially if you intend to sell using any of the discounted pricing strategies that we cover below. The best thing you can do is ask upfront, so you know what discounts and pricing strategies you can apply.
Commonly Used By: Retailers, Ecommerce Retailers, Big Box Stores and Discount Chains
Psychological pricing: Pricing that encourages shoppers to think items are priced lower than they are or that they are getting a good deal.
Have you ever walked into a store or viewed an infomercial and noticed that all of the prices end in 99 cents? That is psychological pricing at work.
Psychological pricing is when a store prices a product at $199 instead of $200 or $4.99 instead of $5. The theory is that customers put a greater emphasis on the first digit of a product price, so $199 seems like a much better value than $200, even though the actual price difference is minimal. It has also been found that the 99 cents ending doesn’t actually change customers’ perceptions of price, but boosts their buying regardless.
By providing customers with a sense that they are getting a bargain or paying less than they are, psychological pricing is a great way to mitigate the psychological pain of loss that customers experience when they part with their money. With this sense of loss lessened, customers have more incentive to make purchases and walk away with a sense of fairness or the feeling that they got a good deal.
Psychological pricing might be the best “bang for your buck” pricing method. For example, in a recent report from Stripe, it found that when it dropped the price by only one cent to create the 99 cent endings, sales increased by several percentage points. Psychological pricing is a great way for businesses to drive sales without running a major sale or striking huge discounts.
Most retailers choose to mark all their goods with 99 cent endings. Some, however, will reserve the power of psychological pricing for their sale pieces to incentivize faster turnover of old merchandise. The 99 cent ending works best for most non-luxury goods, but steer clear of this ending if you sell high-value items as it might decrease the perceived worth.
Commonly Used By: Specialty Stores and the Luxury Market
Value-Based Pricing: A customer-focused pricing strategy in which businesses base their pricing on perceived value or how much the customer believes a product is worth.
The value-based pricing strategy works best for companies selling merchandise with high brand recognition, luxury goods, and unique products that have exclusive features that set them above the competition. It does not work well for businesses that sell commoditized goods or products that lack exclusive features, such as grocery retailers.
For example, say you own a shop that sells vintage luxury handbags. The value of your products is not represented by doubling the production cost price or by any MSRP. In this case, you would want to use a value-based pricing system accounting for designer labels and exclusivity that reflects how much your customers think the bags are worth.
To implement a value-based pricing strategy, you have to analyze three things:
- Your Customers: Conduct surveys, research locally, and understand your target market so that you can learn their value system and price accordingly.
- Your Total Addressable Market: Research industry trends and national consumer patterns to understand the value-based price that the greater population is willing to pay for your products.
- Competitors: Look to your competitors to see how they are pricing their products. Successful businesses in your industry can help you understand the pricing that is helping them prosper.
Commonly Used By: Retailers, Ecommerce Retailers, Big Box Stores and Discount Chains
Discount Pricing: A strategy of regularly selling goods at prices under competitors’ Keystone or MSRP prices.
Discount pricing drives entire business models. Think Dollar Store, Big Lots, and Home Goods. Discount pricing is best for volume-driven businesses that can garner lower prices from suppliers due to volume purchasing.
For the small retailer, an overall discount pricing strategy can leave you with razor-thin profits that easily dip into losses. But occasionally discounting prices via sales, markdowns, seasonal specials, and coupons are excellent tools. With them, small businesses can kick-start drooping sales, unload stale stock, and take advantage of seasonal shopping trends.
Commonly Used By: Retail, Ecommerce Retailers, Convenience Stores, Big Box Stores and Discount Chains
Loss-Leader Pricing: When you select certain products to sell at little profit or even at a loss.
Loss-leader pricing creates a few great deals that draw buyers in with the hope they’ll also buy other profitable goods. For example, if you were a grocer, you might sell a popular item like eggs at a steep discount. The low price of eggs would draw shoppers in—most people need eggs after all—and many would then purchase the rest of their groceries at your store.
This is another iffy tactic for small businesses since you’re taking a chance that your profits on other items sold will cover your loss-leader costs. But, if you can use merchandising strategies to cross-sell or upsell items well, loss-leader pricing can certainly lead to higher sales volume.
Commonly Used By: Discount Chains
Anchor Pricing: A discount pricing strategy where you make a product seem less expensive or like you are offering a deal by creating a higher anchor price that shoppers can refer to when making their purchasing decision.
There are two primary ways that you can implement an anchor pricing strategy. This first is when you display a regular or MSRP price and your lower price on the same tag. Stores like Marshalls, TJ Maxx, and other discount, consignment, or antique stores use this pricing strategy storewide.
Another anchoring strategy that you can use is to display multiple models of the same product together, so that the cheaper model seems like a good deal. For example, if you have ever had to choose a new phone or computer, all the models are typically displayed together with the most expensive model acting as the anchor price. In effect, when a customer chooses one of the less expensive models they feel as though they are getting a good deal compared to the anchor price.
Anchor pricing can work well for small sellers. It’s especially useful if you sell in a niche that has a lot of competition, but not so much that you have to substantially lower your prices to deep discount levels. Often, a standard storewide 5% to 10% anchor pricing discount is enough to create a memorable sense of value that brings shoppers back for more.
Commonly Used By: Convenience Stores, Big Box Chain Stores and Discount Stores
Competitive Pricing: A pricing strategy in which you use competitors’ pricing to set the price of your same or similar products.
Competitor pricing ensures that you are pricing your goods fairly and competitively. You can also use this strategy to set yourself a step ahead by making your prices lower than the competition. Or, if you feel your product is better than your competitions’, you could use their prices as benchmarks for your slightly higher-priced product.
This strategy is best suited for companies that sell products that have reached equilibrium. Batteries are a great example of a product that has reached equilibrium (stagnant or stable in price) because they are widely available in many brands.
Commonly Used By: Retailers with Membership Options, Discount Stores and Big Box Retailers
Penetration Pricing: Pricing a product at a very low price to pull people in, and over time you raise the price.
Penetration pricing is great for promoting new products or products that you have to buy on a subscription or membership basis. The idea is that the low price will penetrate the market and get customers to make an initial purchase. Customers will then continue purchasing.
Examples of penetration pricing include offering a free month upon sign up for a service, selling a new product at a steep price to drum up hype, or offering a limited-time deal.
Commonly Used By: Discount Retailers, Beauty Supply, Office Supply and Grocers
Bundle Pricing: When retailers sell several products together for less than it would be to buy them separately.
Bundle pricing is a great way to sell high volumes of items at a slightly lower profit margin. It is a great strategy for products that go together to make a kit or products that complement each other thematically.
Bundle pricing is primarily used to create a sense that buyers are getting a deal while still encouraging them to make a larger purchase than they had initially intended. This sense of a bargain makes the bundling strategy great for discount retailers or businesses that sell a lot of complementary products like beauty or craft stores.
Commonly Used By: Service Industries
Project-Based Pricing: When you charge a flat fee for a specific service.
Project-based pricing is a great way to create security in the minds of your customers. It creates a compromise between hourly labor and an assured sense of value from the service.
This type of pricing works best for projects with set parameters that are typically cut and dry, and should not be used for more creative projects. For example, nail salons charge a set price for manicures and pedicures or a tire shop offers the same price for wheel removal.
Commonly Used By: Service Industries
Hourly Pricing: When your price is based on an hourly rate that correlates to the length of a project.
This pricing strategy is the flip side to project-based pricing and typically used for projects with more creative elements or less controllable or consistent parameters. While among customers, this pricing strategy tends not to be as favorable as project-based pricing, it makes sense for most service-based industries.
For example, say a company charges a flat “landscaping” fee for their landscaping projects. This pricing structure would not make sense as there are countless types of landscaping endeavors and innumerable sized yards and gardens. In this case, the company would have been better off using an hourly pricing strategy so it could charge accordingly for the variability of landscaping work and make a fair profit.
Commonly Used By: Subscription-Based Businesses, Tech Industries and Cutting-Edge Products
Skimming Pricing: When businesses start with a high initial price and then lower the price over time to attract cost-sensitive customers.
The skimming strategy makes customers more willing to pay for the product or service when the price goes down as they already believe the product to be worth its initial price. Price skimming also helps you to maximize profit margin when introducing a new product.
Price skimming is a great way to recuperate costs if you developed a new product. However, if this is your pricing strategy, you should monitor your sales data continuously. You do not want to deter customers or give your brand a reputation of being overpriced. Use cues from your sales data to figure out when demand is decreasing or stagnant—that’s the time to start skimming that price.
Commonly Used By: Discount Stores
High-Low Pricing: When a company starts by pricing all their goods at a high price and then discounts that price to make sales.
For high-low pricing, the business relies on discount purchases and does not expect to make sales from full-priced items. High-low pricing uses discounts, sales, and clearance to bring their products down to lower prices while still maintaining the perception that their goods are worth the higher price tag.
Consumers love high-low pricing—it gives them a sense of a deal and creates the impression that their goods are of a higher value and quality than what they paid. I know that when I leave a store with a sweater or other product that I got at 50% off, I feel pretty good and believe the sweater to be worth its initial price. The high-low pricing will also incentivize shoppers to return to your business and continue checking in with you for deals.
However, when using a high-low pricing strategy, be careful not to dilute your overall brand value or how shoppers perceive the value of your products. Too many sales and discounts will result in shoppers perceiving your sale prices as the actual value.
Commonly Used By: Subscription-Based Businesses, Retailers that Use Membership Options
Freemium Pricing: When a retailer offers a free service that can be enhanced or upgraded with paid-for, premium services.
The freemium pricing structure helps businesses reel in customers and get them interested in their products or services. You may be familiar with this pricing model from streaming services like YouTube or Spotify.
In their freemium pricing structure, there is a free service where you can play music or videos without charge. But to listen to the entertainment without advertisements or breaks, you have to join their monthly subscription. I don’t know about you, but after a few weeks of listening to ads, I signed myself up for the premium membership and have been a paying subscriber ever since.
Another form of freemium pricing is offering a free trial. The free initial product again gets customers interested in your business overall and will make them more likely to sign up for your paid service in the long run.
Generally, you use freemium pricing on services and products that are low cost and need to be sold in high volumes. There is between a 1% and 10% conversion rate from free trials to paid services through freemium pricing. If you are thinking about using this pricing structure, be sure that your product’s overhead costs and your marketing budgets are low so you don’t end up digging yourself into an unprofitable situation.
Additionally, run your numbers and be sure that the 1%-10% conversions will be able to support you and all of your overhead costs. Don’t forget, you can always change or use multiple pricing strategies if one of them does not serve your products and drive your sales.
Commonly Used By: Hospitality, Tourism, Transportation, Entertainment and Utilities
Dynamic Pricing: When companies use prices that are flexible and changing based on the current market demands.
Dynamic pricing takes into account things like competitor pricing, supply and demand, and other external market factors in setting its prices. This pricing strategy works best for services in the hospitality and transportation industry and essential goods like gas and electricity.
Dynamic pricing can help companies maximize their profits in industries with a lot of ebbs and flows in terms of traffic and demand. For example, a resort might charge $300 for a room during the peak season and $220 for the same room during the off-season. This strategy helps the business owners capitalize on busy times when demand is high, and use lower prices to incentive off-season purchases.
Commonly Used By: Wholesalers, Manufacturers, Artisans and Private Label Sellers
Cost-plus pricing: When you apply a standard markup percentage to all of your merchandise.
Cost + (Cost x Markup Percent) = Sale Price
In cost-plus pricing, the amount by which you mark up your products is equal to the amount of profit you think your products should bring. So if you believe your products should bring you a 15% profit, you mark your price up by 15%.
The cost-plus pricing strategy is a popular method for companies with large volumes of goods and known for its ease of implementation. By applying a consistent profit percentage to every product, you avoid having to price each of your products individually. Additionally, this strategy does not base its prices on its competition or consumer demands—it’s just a flat markup.
Cost-plus pricing is not consumer-focused, so it works well for companies that sell labor-intense products or mass amounts of similar products. Here we will look at how wholesalers, manufacturers, artisans, and craftsmen typically use cost-plus pricing:
- Wholesalers: Wholesalers usually add a flat percentage markup to all goods that pass through their hands. A common wholesale or middleman markup on most consumer goods is 15%, but of course that can vary depending on your industry.
- Manufacturers: Manufacturers use different cost-plus prices depending on the buyer. A manufacturer might sell bulk goods to wholesalers at a cost plus of 100%, just like a keystone markup, but then also sell single units directly to consumers on its website at a cost plus of 300%. This way, it makes more money per unit on smaller sales.
- Artisans and Craftsmen: Labor is the cornerstone of artisanal and craft works, so the cost-plus price represents the value of the labor and the good. For example, if you had a wooden chest built by an artisan, the cost-plus markup might be 70%. The base price represents materials and hours, with a 70% markup that represents the value of the labor and finished product.
3. Measure Profitability and Adjust as Needed
The pricing strategies covered above offer sound guidance on how to price a product. But you also have to ensure that the strategy, or mix of strategies, that you use results in enough income to cover your business’s overhead expenses and leave you some profit to fuel growth.
Overhead expenses that you need to cover include:
- Rent or facilities costs
- Staff and contractor costs
- Events and marketing costs
- Professional fees, licenses, or permits
- Inbound shipping on goods
- Packaging or shipping supplies
- Store decor or website maintenance costs
- Your salary
Once you figure up your average monthly overhead expenses, you’ll know how much you need to make off of product sales to break even. If, after running the numbers, you find you’re operating at a loss, try these three things:
- Raise Prices: If you’re selling a decent volume of goods and your sales aren’t dependent on discount pricing, try raising some prices, particularly on your hottest sellers. This will increase your gross profits to cover your shortfall.
- Change Your Strategy: If you’re just not selling enough products, it’s time to examine your pricing strategies. Are your prices too high? Maybe it’s time to try anchor pricing or set some items to discount promos or loss-leader pricing to get shoppers in the door. Don’t forget, pricing is an ongoing process that should evolve over time to maximize success.
- Lower Costs: It’s easy to let your costs creep up and eat into your profits. The first high-cost things to look at are your staffing needs and space. Do you need what you’re currently paying for? If not, let some of it go and then see if you can increase your profits further by making smart stock buys. Don’t overbuy, but if your supplier offers a discount, free shipping, or extended payment terms on goods that you move fast, take advantage of those buying opportunities.
Product pricing is a matter of choosing the best pricing strategy for your business. This means choosing a pricing strategy that drives sales and maximizes your profit margin. Use the guide above to learn about how the different pricing strategies work and where they can help you thrive.