The right price: How much are your products worth?

Setting prices for your products is one of the most puzzling and stressful aspects of running an online store. Price them too low and you might make a ton of sales but you’ll end up in the red at the end of the month. Price them too high, and although you might win a handful of high rollers more interested in exclusivity than price, it’s unlikely you’ll attract enough of them to turn a profit.

Hitting that elusive pricing sweet spot is tough—“probably the toughest thing there is to do,” according to Charles Toftoy, a management science professor at George Washington University. “It’s part art and part science,” and involves factoring in everything from how much competitors are charging to what customers are willing to pay to the intangible benefits of your products and brand.

To help you get a grasp on some of these factors, we’re bringing you the first in a series of posts on product pricing for ecommerce. Later, we’ll cover the ins and outs of various pricing strategies—as well as a few strategies that have nothing to do with price. Today, we’re kicking things off with a very basic but extremely important question: How much are your products worth?

Answer #1: It depends on your costs and margins

One of the most common approaches to product pricing is cost-based pricing. To use this method, you simply calculate a break-even price for the product being sold, and then add a target margin on top of it to create a profit. This might seem like common sense for most businesses—Marketizor refers to cost-based pricing as “the teething phase”—but many merchants fail to define their costs correctly, and as a result their profits suffer.

Costs encompass far more than the unit purchase price you get from your supplier or the aggregate cost of materials that go into manufacturing your product. Despite the assumption that “selling online is free,” traditional retail expenses like salaries, warehousing, logistics and marketing are all part and parcel of running an online store. You’ll also incur a few extra costs as an online merchant, including platform and hosting fees, and any apps or other services you may want to use.

Once you’ve tallied up all the costs that go into developing, manufacturing, and marketing a product, it’s time to calculate your target profit margin. While we’d all love to build hefty margins into our pricing, competition has a way of keeping things trim. Keystone pricing is a good benchmark for many businesses, where you essentially double the cost of a product to arrive at a 50% markup (and a 33% profit margin). However, in many instances such a high markup is unfeasible (consumer electronics, for example), while in a few others the keystone markup can actually be too low (fine jewelry, for example).

We recommend plugging some figures into Shopify’s profit margin calculator and seeing what works best for your store and customers.

Answer #2: It depends on your customers

Numbers and figures are great and all, but if you ask certain experts the only amount that really matters is the amount customers are willing to pay. “If the customer is willing to pay $1,000 for a product that costs you $10 or even $100 to make, you have a successful product,” says author and recognized pricing expert Mark Stiving. “If the customer is willing to pay $1,000 for something that costs $1,000 to make, you don’t raise your price—you get out of that business.”

But how do you figure out how much your customers are willing to spend? While some companies pay tens of thousands of dollars to third-party consulting firms for in-depth market research, all it really takes is an informal survey or two of your existing customer base. QuestionPro has a basic template that will give you an idea of some of the types of questions you might ask, but keep in mind that consumers will naturally choose lesser amounts than they’re willing to pay in the real world if presented with multiple price-points. A much better approach—as Tyson Gingery of Inquisium suggests—is to “ask some respondents if they will pay price x and others if they will pay price y, and then compare the results of the two groups.”

Whether you outsource your market research or conduct it yourself, most companies find that their customer base is comprised of two or three distinct groups (for example, the bargain hunters, the convenience shoppers, and the luxury set). If you decide to go after a price-sensitive segment, you’ll price your products lower and make that a big part of your value proposition. However, if you decide to go upmarket, your value proposition will be very different—rather than highlighting deep discounts or savings bundles, you might shift the focus to the quality or exclusivity of your product.

Answer #3: It depends on your competition

At last count, there were more than 12 million ecommerce sites on the internet, and your customers are never more than a click away from any one of them. In fact, with the rise of comparison shopping engines, which collect offers from from multiple online stores and display them on a single results page, you might find your product and price cozied right up to the competition’s. With that kind of convenience, you can’t really blame your customers for looking—in fact, you’d be wise to do the same.

Tim J. Smith, founder and CEO of Wiglaf Pricing, there are three important questions to ask yourself when it comes to assessing the competition: Who provides an alternative to my product? Is mine better or worse? And does the customer care? If your product is superior, highlight what makes it so and price upwards. If yours isn’t quite as good, undercut the competition and price downwards, luring customers away from their store and over to yours.

As your competitors’ prices change, so should yours. Thanks to automated price tracking software like Prisync and Kompyte, keeping apprised of price fluctuations in the market isn’t nearly as frustrating and time-consuming as it used to be. These days, you can monitor up-to-the-minute price changes from your competitors and respond to them immediately—not only by dropping your price the instant the competition does, but also by raising them when you think it will be to your advantage.

Taken to the nth degree, some merchants are using competitor pricing data to automatically trigger updates to their own prices depending on certain rules they define. This strategy is known as dynamic pricing, and according to Econsultancy it has the power to improve gross margins by 10% or more. They note that some of North America’s top retailers—Amazon, Walmart, Best Buy and Sears—all incorporate dynamic pricing into their pricing strategies, which, in the case of Amazon, means that prices are changing every 10 minutes on average. (Arguably a big part of why sales increased 27% between 2012 and 2013.)

Wrapping up

Pricing your products competitively but profitably is tough, and there’s no one strategy that will work for every ecommerce business. Having a solid understanding of your costs, margins, customers and competition is a good foundation to build upon. In our next post in this series, we’ll be delving deep into some of the most common and profitable pricing strategies—as well as a few lesser-known ones—so stay tuned for more product pricing goodness.

In the mean time, let us know what factors you consider when setting your prices. Is there anything we missed?