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Are you comfortable with your strategy for setting retail prices? If not, you have plenty of company. Most small business owners don't have a clear process for pricing their products. They don't have a simple selling price calculator that gives them the answers for a pricing strategy. Developing a pricing strategy requires a mix of hard market data with a bit of instinct. It's never perfect, but a practical method exists that combines all the murky variables to come up with a pricing plan.
Let's say you're the owner of Hasty Hare Corporation, a sneaker manufacturer for rabbits. Your company is coming out with a new lightweight, eco-friendly sneaker, Blazing Feet, and is looking for a pricing strategy. How do you decide? Let's go through the process.
What Are Your Product Costs?
The foundation of a pricing method starts with determining a product's cost. The cost to produce your product is its variable costs of direct labor and materials plus a per-unit allocation of fixed overhead expenses. For a retailer, these costs would be the price of the products purchased for resale plus overhead expenses.
You would then use the product’s cost to find the sales volume needed to break even with the various suggested retail prices indicated by each pricing strategy.
The accountants at Hasty Hare have calculated that the product cost for each pair of Blazing Feet is $85. Costs are slightly higher than normal because eco-friendly materials are more expensive.
Who Are Your Customers?
You must understand the mindset of your customers? What features are they looking for in a product? And how much are they willing to pay for those features? How can you position your products so that consumers will choose your offers over the competition?
You believe that the target buyers for Blazing Feet are high-income millennials who prefer products that are friendly to the environment.
How Strong Is the Competition?
Look at your competitors. How are they pricing their products? Are they positioned with stable premium prices, or do they frequently offer sales with discounts and coupons? Do your competitors offer similar products? If so, how can you differentiate your lines from the competition?
At the moment, your competitors do not offer eco-friendly sneakers that can compete with Blazing Feet.
What Are the Choices for Pricing Strategies?
Following are three of the most common pricing strategies:
Low-price discounts/penetration: A low-price strategy means offering the cheapest price in the market. This method relies on selling large volumes and making low profits. Walmart is an example of a company using a low-price high-volume strategy.
Keystone: The benchmark pricing strategy for retailers is keystoning. This method sets the retail price at double the product's cost. In other words, a product that cost $60 delivered to your warehouse would have a suggested retail price of $120.
Premium/skimming: Use premium pricing if you can show that your products have a distinct value over the competition and are worth the higher prices. Skimming is when you can keep premium prices and earn higher profits until your competitors start offering similar products and you are forced to lower your prices.
What Is the Suggested Retail Price?
After analyzing the mindset of your customers, studying the competition and determining product costs, you are ready to choose a pricing strategy and come up with a suggested retail price. The choice of a low-price strategy, keystoning or premium pricing will depend on how you want to position your products in the marketplace. You will have to apply your instincts about which strategy will be successful. Remember, no decision is forever; changes can always be made as a result of unsatisfactory performance and shifting consumer preferences.
Since the eco-favorable Blazing Feet sneakers do not presently have any competition, you could decide to set a premium retail price at $215/pair. At this price, the margin calculator shows a gross profit margin of 60% (($215 - $85)/$215).
The case of Hasty Hare is just an example of the process used to arrive at a suggested retail price. Each small business owner will have a unique pricing situation, but the approach will be the same. After deciding on a pricing strategy, you should continue to check the results and be willing to make changes when something is not working.
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- EDUCBA: 10 Most Important Pricing Strategies in Marketing (Timeless)
- Penn State University: Pricing Strategy
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for National Funding, PocketSense, Bizfluent.com, FastCapital360, Kapitus, Smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.