What Is the Most Important Factor in Product Price Setting?
The price of a product not only has to cover the costs necessary to manufacture the product but also the company’s other costs -- such as administrative overhead and office expenses -- and generate a profit. If the price of the product is set too high, sales may decline as customers find a similar product elsewhere for a lower price. Too low of a price means you forgo potential profits. The most important factor in product price setting is choosing a price low enough that customers perceive they are getting a good value relative to what your competitors are offering and the prices they are charging -- but yet high enough to generate a profit.
The cost of goods sold is the direct expense of manufacturing the product, including direct labor and materials. Lowering the cost of goods sold allows you to increase the profit from each sale or to lower the price if necessary and still maintain profitability. The business will not survive if the price of the product consistently barely covers the cost of goods sold. Sometimes, companies lower the price for a new product introduction below cost temporarily to entice new customers. According to Forbes, it's been rumored that Amazon originally priced its Kindle electronic reading device below cost when it debuted in 2011 in order to sell digital books and to beat out the competition. Other examples would include products that require refills, such as inkjet printers. The product may be sold at near cost, with the profit made on the ink cartridges.
Your competition has an impact on your pricing. Customers will be hesitant to buy what they consider a very similar product for a higher price. Convincing the customer that your product is a more effective solution to his problem allows you to have a higher price. Value-oriented customers may prefer a lower price. If sales increase because of the lower price, the profit potential could remain about the same. For example if you sell 1,000 gizmos at $2 each, revenues will be $2,000. Lower the price to $1.75 and you would have to sell 1,142 gizmos to reach $2,000 in total sales. But it is possible the lower price will stimulate more than 1,142 unit sales -- and profits will increase.
Customers expect to pay a certain price for merchandise. For example, a luxury car may cost upward of $50,000, while an economy car costs around $20,000. Pricing significantly above or below the expected price could result in lost sales. The luxury customer may wonder why a product is so much less than other similar products on the market and conclude that there must be something inferior about the lower-priced product. An economy-car customer may not see the value in a higher-priced model.
A key factor in pricing is whether the product will be sold on a wholesale basis or retail. Products sold wholesale are priced at about half of the retail price. The product is then marked up 100 percent by the retailer. For example, if a gizmo costs you $1.25 to manufacture, you might sell it wholesale at $2.50. The retailer will then price the product at $5.