This article is part of a larger series on Retail Management.
Pricing products is 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 four-step guide on how to price products, from determining your costs to making adjustments and embracing the fluidity that will maximize your profits.
Step 1: Determine Your Costs
Before you can price your 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 your product sales need to generate.
In general, retail costs fall under two categories–cost of goods sold (COGS) and fixed costs.
Step 2: Set Your Prices Using a Pricing Strategy
Once you have a grasp on your outgoing expenses, it is time to get into the weeds and start actually pricing your products. You will typically begin with a pricing strategy. Pricing strategies create a uniform approach to pricing each of your products and can help ensure that your prices are fair, consistent, and profitable.
When selecting a pricing strategy, you will want to take into account a few factors that might affect demand and pricing for your specific situation.
- Industry standards (ensuring that your prices are competitive for your particular space)
- Legal regulations (are there certain prices or ranges you must adhere to?)
- Net and gross margins
- Local purchasing power
- Product costs
- Overhead costs
- Brand positioning (luxury, bargain, etc.)
For example, a store that sells T-shirts in a middle-class neighborhood might price their tees at $25 based on their pricing strategy. Whereas, a similar store that sells the same T-shirts in a wealthy area might add a couple of dollars to their prices, and sell them at $35. Because of the different locational factors affecting these stores, both stores will likely be able to sell their shirts with similar success. Not only that, but because the two stores’ fixed costs are likely different, they will probably result in similar net profits.
While using a pricing strategy, always account for the idiosyncrasies of your specific situation and adjust your pricing accordingly.
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 3: Calculate Your Gross & Net Profit Margin
Once you have set your prices, it’s time to determine the next variables: your profit margins—gross and net.
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.
Gross Profit Margin Calculator
Use the calculator below to determine your gross profit margin.
According to ongoing research from NYU’s Stern School of Business, the current average gross profit margin across the general retail industry is 24.3%.
You can also calculate your gross profit margin by hand using 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%)
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.
Net Profit Margin Calculator
If you don’t want to do the math by hand, you can use the net profit margin calculator below.
As of January 2022, across the retail industry, net profit margins average 2.65%.
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 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%)
Profit Margin vs Markup
Another metric that you might be familiar with in the same context as your profit margin is markup. Where your profit margin refers to your business’s net revenue minus the cost of goods sold, your markup is the difference between the selling cost and wholesale or production cost of your merchandise. You can learn more about margins and markups with our Retail Margin & Markup Calculator article.
Step 4: Monitor & Adjust
The steps covered above offer sound guidance on how to price a product. But, once set, you have to ensure your pricing covers expenses and leaves you some profit to fuel growth. You will need to monitor your results going forward and adjust as necessary.
If, after running numbers, you find you’re operating at a loss, you may simply need to raise prices, particularly on your hottest sellers, or work to lower costs. Or you may delve deeper into pricing strategies, such as anchor pricing (displaying a higher initial price next to your current price to make your product appear less expensive) or loss-leader pricing (selling some items for less or even at a loss to get customers into your store).
Your pricing strategies will evolve over time as your work to maximize success.
Price Elasticity of Demand
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:
% Change in Quantity Demanded / % Change in Price = Price Elasticity of Demand
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.
How to price products is a big question that retailers have to answer to run their business effectively. When you price a product well, you stand to both sell them and make a good profit. When you over- 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.