Even the greatest business idea in the world can struggle for take-off without the right pricing strategy. But knowing how to price products is no easy feat, as you'll need to take into account your costs, your customers' spending power, and when to charge VAT. In this guide we'll help you work out how to price your products so that all your hard work means you can take home the profit you deserve.
What is a pricing strategy?
There is more to pricing products than simply plucking numbers out of thin air. A pricing strategy is your plan of action for how you'll price your products or services, and the reasoning behind it. Before you decide upon a pricing strategy, you'll want to consider the following:
Who are your customers?
Money talks, and getting to know your target market will go a long way to informing your pricing strategy. For example, do your target customers have high levels of disposable income? Or are they looking to budget? Think about your own behaviour as a customer. When making a purchase, we all make a number of considerations: price, quality, convenience, customer service, and value - the price relative to quality.
Our decisions also depend on what we're buying; for example, you might be happy to splash out on a rare purchase like a sofa, but prefer to do the regular food shopping on a shoestring. Knowing what your customers want, and can afford, will help you decide how to calculate your product pricing.
How do your competitors price products?
Doing your homework on the sale prices in your industry is a good way to settle on a pricing strategy. This applies both to your customers' expectations - how much are they willing to pay for a slice of pizza? - and the competition - what do other companies charge? You should also consider the quality of the competition, and whether there is space in the market for your offering at a certain price point.
What are your costs?
In an ideal world you might want to charge low prices for your customers, but in reality, your pricing strategy will be shaped by your running costs. If you're selling food, you'll need to consider the cost of everything from ingredients to packaging, as well as basics like labour, gas and electricity that apply across many sectors.
Digital products may incur fees for online services and postage; physical products may come with storage costs; and many services require time and expertise, to give just a few examples.
Examples of pricing strategies
Once you've done your research on your target market and competition, what should your pricing strategy be? Here are some ideas:
- High volume, low margin - If you're looking to target customers on a budget, you might be happy to accept a lower price point so long as you can make a high number of sales. Retailers like supermarkets are classic examples of this pricing strategy. You'll need to ensure you have the capacity to meet the volume required to turn a profit, and you'll ideally want repeat customers, so consider whether your product or service is something that could attract regulars, like food or drink.
- High margin, low volume - If you're confident in the quality of your product, and you don't need to make a large number of sales to stay afloat, you could consider a higher price point. The advantage is that you don't need to keep up with the demands of volume, so this may be a sensible pricing strategy if you're selling items that people buy infrequently, like designer clothing or antiques. The drawback is that you'll have a smaller pool of customers, as fewer people are able to afford big-ticket items on a regular basis.
- Buy now, pay later - One way to combine a high margin pricing strategy with a high volume of sales could be to allow your customers to buy your products or services 'on finance'. Many retailers who sell expensive items such as televisions or furniture offer point-of-sale finance agreements, which are often interest-free for a certain period. Not everyone has wads of money available at any given time, so this product pricing strategy could widen your customer base. However, your customers will need to make the repayments on time, or you'll be forced to charge interest or in a worst case scenario, take legal action to recover any unpaid amounts.
How to calculate product pricing
If you've worked out your pricing principles and you're ready to do some number crunching, here are some different ways you can calculate your product prices:
- Keystone pricing - If you want a quick and easy way to figure out a profit margin, simply double the price you paid for the product, giving you a 50% initial mark-up. This saves you having to get the calculator out, and provides a healthy margin on the face of it. However, if there are large costs associated with a product - from shipping to locating rare parts - you may be underselling yourself.
- Retail price - A retail pricing strategy means you can adjust your mark-up as demand dictates. To work out a retail price, first take the cost price of the item - say, £10 for a pair of shoes. Then minus your percentage markup (say, 60%) from 100, giving you the number 40 in this instance. Based on these figures, you'll need to divide your cost (£10) by 40, then times by 100. Still with us? Here's the maths: £10 ÷ 40 x 100 = £25. In other words, you can sell the pair of shoes that cost you £10 for a retail price of £25. Simple!
- Recommended Retail Price - If you want to save yourself time, simply use the manufacturers' Recommended Retail Price (RRP), sometimes known as a list price or Manufacturers' Suggested Retail Price (MSRP). This is a simple and standardised way of pricing that can ensure your pricing strategy is in line with your competitors.
Do I need to add VAT to my prices?
If your business generates sales above the current VAT threshold - £85,000 for a 12-month period ending in 2020/21 - you are required to register for VAT. The standard VAT rate is 20% for most goods and services, but some goods - such as children's car seats -have a reduced 5% VAT rate, or its 0% for items like donated goods.
It's less simple for food and drinks businesses; restaurant and takeaway vendors must charge standard VAT on hot takeaways, home deliveries or food eaten on-site, but don't need to charge VAT for cold takeaway food unless it's eaten in a designated space, such as shared tables at a food court. It's worth keeping up-to-date on VAT exemptions, which are sometimes introduced on a temporary basis.
Once you've worked out whether your business is liable for VAT, you will need to decide how to price your products. Essentially, you can either add 20% to the product price, meaning the customer pays extra, or you can absorb the cost within your business and keep prices the same. So, if you're planning on scaling up, factoring in VAT rates should form an essential part of your pricing strategy.