Pricing is the foundation of every e-commerce business. It directly affects your business’s profitability and long-term sustainability, so you should be strategic in this area. You need to price products optimally to entice customers and make profit.
This guide will teach you how to price a product effectively and boost sales. Read on to learn how to determine the price of a product with our step-by-step formula, strategies, and common mistakes to avoid.
Pricing is the first thing customers look for when ordering a product. Customers love getting good deals, so they’ll seek competitive prices when ordering items from your store.
Pricing directly affects your e-commerce business's revenue, profit margins, and competitive advantage. It largely determines your store’s long-term profitability amid increasing competition.
Every online seller needs optimal prices to attract and retain customers, and these prices depend on factors like niche, value proposition, and competition. Below, let’s explore the key factors to consider when pricing your product.
The first factor to consider when setting prices is the cost of manufacturing a product. After all, you need to sell higher than your base costs to make a profit.
Consider direct and indirect costs to know how to price a product. Direct costs include production materials, labor, and overhead. Indirect costs include rent, utilities, licenses, and marketing.
Add the direct and indirect costs of obtaining products and set prices at a level that will recoup these costs and earn profits. This will help you build a long-term profitable business.
Your competitors’ prices are a good starting point for setting yours. Customers often research multiple options when seeking a product, so you need prices that align with competitors to avoid scaring them away.
Setting prices too high will spur customers to patronize competitors, and setting prices too low will undercut your potential profits. Research your closest competitors and keep your prices in line with theirs.
Differentiating factors like quality and brand perception should be considered during competitive research. Competitors with stellar reputations can set high prices, but setting yours similarly high can scare away customers.
New brands will likely need lower prices to build market share but can set high prices over time after amassing a customer base.
Value proposition and customer perception are key to knowing how to determine the price of a product. How customers perceive your brand affects their willingness to pay higher prices. Hence, premium brands can charge steep prices and earn more profits.
Creating a value proposition also helps you charge higher prices. Convince customers that they’re getting good value by illustrating how the product solves a pressing problem. For example, you can promote an office chair with the perspective of preventing ergonomic pain and improving long-term health.
Price anchoring is another tactic for charging premium prices. It involves setting a higher starting price point for a product but emphasizing its current discount, e.g., a $100 watch selling for a discounted $75. The discount convinces customers they’re getting a good value even while paying premium prices.
Businesses use standard strategies to set optimal prices, including value-based, cost-plus, competitive, and dynamic pricing. Understanding these strategies is crucial to knowing how to calculate how much to charge for a product, so let’s explore them.
Cost-plus pricing determines the price by adding a fixed profit margin to the production cost. Suppose you want an 80% profit margin. You’ll simply add 80% to the cost of all products to get the desired profit. A $100 item will sell for $180, a $200 item will sell for $360, and so on.
This model is popular, especially with dropshippers, because of its predictability. You’ll simply set a specific percentage above the production cost to make your desired profit. Zendrop lets dropshippers import products into their stores with automated cost-plus pricing rules.
However, cost-plus pricing has limitations, such as not considering customer demand when setting prices. Your desired profit margin might be too high for customers, leading to lower product sales.
This strategy involves setting a price based on the perceived value to the customer. The challenge is determining the perceived value, and the solution is to have a precise value proposition. Promote products with the perspective of solving a major problem, e.g., “This pouch protects your valuable smartphone and helps avoid costly repairs.”
Understand customer pain points and promote products that solve these pain points. Customers who detect good value in your product will be more willing to pay higher prices.
This model involves setting prices based on what competitors charge for similar products. It's the best price model for saturated markets where customers pay little attention to branding. Often, a market leader sets the price, and competitors use it as a guide.
This pricing strategy involves constantly researching your competitors’ websites and catalogs to find their prices. If a close competitor increases or reduces prices, it’s a signal to follow, so you’ll need to monitor price changes frequently.
Constant price monitoring can be time-consuming, but it helps you attract customers in intensely competitive markets.
Dynamic pricing involves adjusting real-time prices based on factors like demand, seasonality, and competition. It’s commonly used in e-commerce and other sectors, such as travel and hospitality.
Suppose you sell sports jerseys and observe increasing demand for a team that just won a championship. You can increase the prices of the winning team’s jerseys to earn higher profits. Customers will likely pay higher prices because of the heightened demand.
Dynamic pricing lets you optimize pricing to capture profits and manage inventory more effectively. However, overdoing it can cause customer dissatisfaction.
Learning how to price an item involves following standard formulas, such as cost of production + 60% margin. Below, let’s explore a step-by-step pricing formula online retailers can follow.
The first step is calculating your direct (fixed) and indirect (variable) costs. Direct costs include the materials and labor required to produce items. Suppose you’re selling apparel. Your direct costs include the materials and the workforce needed to manufacture the apparel.
If you’re dropshipping products, the direct cost is the price of obtaining every product from a supplier. Many entrepreneurs choose to dropship because it removes the stress of manufacturing products and managing inventory. You’ll outsource these processes to third parties like Zendrop, which offers high-quality products with industry-leading shipping.
Indirect costs are mostly overhead expenses like rent, utilities, marketing, licensing, and insurance. These costs are significant for e-commerce businesses, so they need to be considered when setting prices.
Add your annual overhead cost and divide it by the number of products. This figure provides a good sense of each product's indirect cost.
Below is an ideal example of cost calculation.
Cost of materials | $20 |
| Labor cost per product | $5 |
| Packaging | $2 |
| Marketing | $1 |
| Shipping | $5 |
| Overhead (the average for each product) | $3 |
| Total cost | $36 |
Setting your desired profit margin is the next step in determining a product's price. Your desired profit margin should be based on industry standards, competition, and general business goals. For example, if 50% is the standard profit margin in your industry, you should target this range to stay competitive.
Some industries tend to have higher profit margins than others. For example, fashion and jewelry have much greater profit margins than books. The average profit margin for jewelry hovers around 42% to 47%, while bookstores range from 2% to 10%.
Research extensively about industry profit margins before setting prices. You should weigh industry standards against your personal profit goals and strike a balance. Usually, new brands can target lower profit margins to build a customer base, then gradually increase prices after building a reputation that’ll entice buyers to pay more.
Price-setting isn’t a one-and-done activity. Knowing how to price a product includes constantly analyzing the market for new clues. Check competitors’ price changes to guide yours. If close competitors hike prices, you can follow their lead to capture more profits. If they reduce prices, you can follow their lead to remain competitive.
Monitor customer demand to guide your price-setting. You can raise prices for products experiencing heightened demand. Customers will tolerate higher prices stemming from demand constraints.
Pay attention to price elasticity, which measures how much demand for a product impacts prices. Generally, prices rise when demand increases for a product, but customers can only tolerate a certain degree of price increase.
If your product has many alternatives, limit the price increase to avoid driving customers to competitors. If you sell exclusive products with few alternatives, customers will be more tolerant of increased prices during high-demand periods.
“How much should I charge for my product” is an open-ended question with no definite answer. Answers change frequently according to market conditions, so trial and error is necessary to strike the right balance. You can always test new strategies if the initial ones don't work out.
For example, you might start with cost-plus pricing and notice that it doesn’t work. You can switch to value-based or dynamic pricing, or you could use different pricing strategies for different products.
The most important aspect of pricing is earning enough to cover expenses and provide some profits. Once this is achieved, you can test and adjust pricing strategies according to market conditions. Testing is essential to knowing how to price a product for retail.
Underpricing and overpricing are two core mistakes e-commerce entrepreneurs often make. Avoiding these mistakes is a key part of learning how to price a product, so let’s explore them further.
Online sellers often set much lower prices to outdo competitors. This strategy can be excused for new brands trying to win market share but can reduce long-term profitability.
Underpricing can also adversely impact brand perception, as customers often consider cheap products substandard. This perception is more pronounced in some niches, like jewelry and accessories, where buyers associate pricing with quality.
Competitive research helps you avoid underpricing as much as possible. Research your competitors’ prices over time and keep your prices aligned. You can apply dynamic pricing during increased demand to avoid underpricing. You can also offer bundles and discounts to convince customers to pay more for your products.
Many e-commerce retailers charge higher than they should, alienating customers. This mistake often stems from a lack of competitive research when setting prices. It can reduce long-term profitability, so it should be avoided at all costs.
Competitive research helps prevent overpricing. Evaluate your competitors’ prices and keep your prices similar to theirs. You can raise prices during times of heightened demand but keep your price raises in line with competitors.
If you raise prices and notice a sales drop, it’s a signal to revert to previous prices. Testing is part of learning how to price a product, so don’t hesitate to adjust prices in response to customer feedback.
The ideal profit margin depends on several factors, such as niche, cost of goods, and customer demand. Different niches have different average profit margins, so research yours when setting prices. You can earn as much profit as industry trends permit.
An ideal way to price a product is to set a specific percentage above the cost of obtaining it. For e-commerce businesses, a profit margin of 50% and above is ideal, so a $10 product can be priced at $15 or more.
You can conduct competitive research to guide your online store’s prices. Always align your product prices with competitors' to avoid scaring away customers. Other factors like customer demand and value proposition should also be considered when setting prices.
Market research, customer perception, and customer demand are the main factors to consider when learning how to determine the price of a product. These factors guide you in choosing the optimal prices that’ll entice customers.
First, you need to consider the cost of goods sold (COGS), which is the price you pay to your supplier for the product. Additionally, you must factor in shipping costs, whether it's a flat fee or variable, based on the supplier or your delivery method.
Market research is also crucial — you should look at competitor prices, demand, and customer preferences to understand the going rate for similar products. Another important consideration is your profit margin. This means determining how much you want to earn from each sale after covering costs. Finally, the customer perceived value plays a role, as higher-quality or branded items can justify a higher price.
Imagine you're selling a wireless Bluetooth speaker through a dropshipping model. You find a supplier offering the product for $15, and the supplier charges an additional $5 for shipping. So, COGS is $20 ($15 for the product + $5 for shipping).
Next, you conduct market research and discover that similar wireless Bluetooth speakers are selling for around $40 on most online platforms, with some ranging between $35 and $45 depending on features and brand reputation. This gives you an idea of the market price and helps you understand the demand for such products.
You then decide that you want to achieve a profit margin of around 50%. To calculate the selling price, you can take your COGS of $20 and apply a 50% markup, which would give you a selling price of $40. However, you also want to consider that the market average is around $40, so pricing your product at $39.99 would make it competitive while maintaining the desired margin.
