The product management guide

Aha! helps product managers get their mojo back

How should I price my product?

The goal of a business is to provide value that customers are willing to pay for. Setting a price is ultimately about finding the dollar amount that people will pay for a product. Arriving at that price requires knowing customers well and understanding what matters most to them.

Many businesses make mistakes in the area of pricing, setting their prices too high or too low, or choosing the wrong pricing structure altogether. The result is that they do not find enough customers who will buy the product, and their business fails to take off. Setting a price is not an easy decision to make, and should not be treated in a casual manner.

Oftentimes, companies need to test different prices to see what will get the best response. Pricing is also about market perception and making sure that the value offered lines up with the asking price.

That is why, like the rest of the business, businesses should take a strategic approach to setting prices for their products. Taking time to spell out these details first helps them to find the right price for their products. Businesses should consider the following:

The type of product sold

They know whether they are selling software, hardware, or a service, some kind of goods or intellectual property. But is the product a comprehensive solution or a vertical product that simply performs one function? Knowing this will helps to set a price that is in line with what is offered.

The market landscape for the product

Businesses must define who their customers are and what they want, the competitors they face as well as their pricing structure. They should also describe the opportunity in terms of how much of a market share they hope to take with their product.

The positioning of the product

They should also consider whether they are a value brand appealing to practicality or a luxury brand appealing to the rich. How does the product compare to other products they sell (or may sell in the future?) A low price can be a point of differentiation for some products and companies, like Walmart; however, prices must be higher than costs.

The unique value proposition of your product

What sets the product apart from the competition? Customers should perceive that the product is different from other available products. Differentiating factors can include additional features or an ultra-responsive support team that helps the product stand out as unique.

Coming up with your price

When arriving at a price, businesses must factor in the cost as well as the desired perception of the product in the marketplace. They must also cover their fixed and variable costs, which include costs for producing, maintaining, and promoting the product.

They must consider the demand for the item, which can change depending on customer preferences, the pricing of related products, the income level and number of potential buyers, and expectations of future price changes.

With that said, here are different pricing options that companies can consider:

  • Cost-plus pricing. With this pricing option, the selling price is determined by adding a percentage markup to the unit cost of a product. This takes into account direct material costs, direct labor costs, and overhead costs, then adding in a certain profit margin.
  • Targeted return pricing. This type of pricing considers what an investor would want to earn from their investment. The price is calculated based on the investment amount that must be recouped, plus the expected profit for an investor. The price is then adjusted for the time value of money, which assumes that it is better to receive the money sooner than later.
  • Value-based pricing. With this pricing model, a business focuses on what the customer perceives the value of the product or service to be. Customers may be willing to pay more for a product they perceive to have higher value. To arrive at a value-based price, companies must conduct research to analyze customer data as well as how their competitors are pricing their products.

Additional considerations

In addition to the exact price point, there are many different pricing models which may be best suited to a product. Here are some of the most common structures that companies use, and their advantages and disadvantages:

  • Flat fee (one-time cost). This pricing model has the advantage of being straightforward for customers; however, businesses need to continually find new customers who are willing to make a one-time purchase.
  • Subscription (pay as you go). A subscription-based model can be an attractive option for customers, provided that the cost and terms are clearly stated. The subscription model provides recurring revenue for the business and help with with cash flow. However, it may take more effort to earn the long-term commitment from customers.
  • Freemium with upgrade. The product can be free for some portion of the offering and then paid for the additional value that is provided. This pricing model can be an entry point for new customers. The danger is if customers derive enough value from the free part, they may see no incentive to upgrade. The freemium model can also harm the perception of the product, devaluing it in the eyes of the customer.

The psychology of pricing

Customer perception is a major consideration when determining pricing, but it is not always straightforward. That is why the product with the lowest price does not always win out.

Consumers are value-conscious, but they will not always opt for the lower-priced option if they feel there is more risk involved. For example, when comparing bottles of aspirin, consumers opted for the higher-priced brand that they recognized as a safer bet.

Marketers often make subtle tweaks to prices that result in more sales. For example, many retailers charge $19.99 for a product rather than a flat $20. Consumers have learned to equate prices ending in 9, 99, or 95 with bargains or value pricing. Researchers have found that using "charm prices" like these increase sales by 24% compared to “rounded” price points.

Pricing is a strategic decision and will have a massive impact on the success of the business. Ultimately, it comes down to what the target customer is willing to pay for the product. Once the business has a clearer picture of what they are selling, who they are selling it to and why, they are in a better position to judge whether their pricing aligns with the larger strategy for their business.

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