Retail 101: How to Price a Product

Pricing strategy is a big piece of the puzzle for retail businesses. Part marketing, part psychology, and part guesswork, pricing a product can be one of the more difficult aspects of running a retail store.

“Very few merchandising decisions have as sweeping an impact on business performance as how to price items in the product assortment,” said Josh Pollack, associate partner and pricing practice lead at the Parker Avery Group.

“When set thoughtfully, pricing can be a major factor in conveying the brand positioning and value proposition of a retail concept. Pricing approaches differ significantly when considering short-run designer garments (where a higher price might add to the cache) than when planning for everyday pantry items, such as eggs,” said Pollack.

In this article, we’re going to discuss pricing methods and throw the floor open to retail experts like Pollack and others, who will give you their suggestions and tips for getting your product pricing right. We’ll cover:

Why getting pricing right matters
The different methods of pricing
How to select the right pricing method
Examples of pricing strategies
Retail product pricing strategies
How to evaluate pricing strategies

Let’s start with some more thoughts on why pricing matters so much.  

Importance of setting the right price 

“The right price is a sweet spot that keeps your product competitive and valuable in the market while safeguarding your profit margin and taking into consideration all your costs,” said Ian Sells, CEO and Founder of Rebate Key. 

Different product pricing methods

Pricing really is a balancing act. “Setting prices too high will prevent customers from buying your product, but setting them too low may mean that you don’t cover enough of your costs and aren’t making an appropriate profit margin,” said Darren Litt, the co-founder of Hiya Health, which sells children’s multivitamins.

So let’s take a quick look at some of the ways retailers can calculate product prices.

Cost-plus pricing

Otherwise known as markup pricing, cost-plus pricing involves calculating the production costs of a product and adding a fixed percentage to arrive at an approximate profit margin. 

Production costs include labor, materials and overhead expenses. Remember that different products will require different markups to balance profitability with prices that are reasonable to  consumers. 

Cost-plus pricing is beneficial because of its simplicity. You don’t have to collect data or conduct research, aside from analyzing your own production costs. Plus with a rise in economic and supply chain issues, production costs are rising. Because of this, you can easily explain price increases to inquiring customers.

However, it’s not a one-size-fits-all solution. Estimates of transaction volume could be incorrect, so your markups may be inaccurate. And because there’s no outside research involved, you may end up pricing your products too high or low in comparison to competitors. 

Value-based pricing

Value-based pricing refers to charging according to how customers view your products’ worth. You calculate what customers are willing to pay for your product before adding any costs. With this method you need to know what other companies charge for similar products so you can establish your ideal target market.

Value-based pricing comes into play for businesses that are closely in tune with their customers’ wants and needs. A business may use value-based pricing when they offer a product that isn’t sold by competitors. For example, a retailer that specializes in vintage jewelry. Their product selection is unique, and their target market consists of people who collect jewelry that isn’t mass-produced. For that reason, this retailer can apply value-based pricing to their products.

Interestingly, your brand may factor into whether you can use value-based pricing. Even if your product isn’t that unique (for example, a women’s clothing store) if your business has high brand awareness and a large customer base, consumers may be more likely to purchase your products at a higher price versus a competitor without those qualities. 

Like cost-plus pricing, this method won’t work for every business. Extensive customer research is involved, which can be time-consuming and resource-heavy. However, you can only benefit from knowing as much as possible about customers. It’s also not an exact science–a miscalculation could lead to customers perceiving your products as overpriced or undervalued.

Competitor-based pricing

Competitor-based pricing is a strategy in which you price your products relative to your competitors. Research your competitors in the market and look into the similarities in your product ranges. Calculate pricing averages and decide where your prices should fall on average–higher, lower or matched. Are you losing margin by discounting too heavily, or are you charging a lot more than businesses that sell similar products?

As long as you’re still pricing in service of your target market, competitor-based pricing is relatively simple and safe. Keep in mind that it’s not the ideal long-term solution. If you change prices based simply on what your competitors are doing, you could be doing a disservice to your business’ bottom line. 

Find ways to improve your long-term pricing strategy. Investing in marketing and advertising to build better brand awareness is just one way to stand out among competitors so you can be more flexible with your pricing. 

Elasticity-based pricing

‘Elasticity’ is how customers respond to price changes. In other words, it’s how supply and demand are affected by the price of your product. You can measure it by analyzing the prices and sales quantities of past transactions and comparing the changes in price to changes in unit sales. 

An elastic product is one where price changes impact its demand. An inelastic product is one that people will continue to buy a product despite price increases. It usually isn’t black and white–items can be considered ‘relatively’ elastic or inelastic. 

But, determining how customers respond to price changes is a worthy endeavor for your business. Even if you don’t choose to use this as your only method of pricing, it can provide you with valuable information related to the demand of your product based on your prices.

Cross-product based

Some items within a range are best priced in relation to others. For example, different flavors of the same size and brand of yogurt or cat food are frequently priced the same. The aim is to price complementary products effectively so product demand increases.

Hot dogs and hot dog buns are an example of complementary goods. If you decrease the price of hot dog buns by a dollar, demand will in turn rise for hot dogs. 

Gross margin-based pricing

Gross margin is your business’ revenue after taking into account COGS (cost of goods sold). If the gross margin has decreased, businesses often cut production or labor costs. Alternatively, they may try to improve the gross margin by increasing prices. 

This is an important metric not only for determining prices, but for assessing the overall health of your business. Keep in mind that gross margin should play a role in any pricing decisions you make.   

Keystone pricing

This method involves pricing products at a 50% markup. Keystone pricing is very simple to implement. It may appeal to larger businesses with a lot of inventory–a quick calculation makes pricing simple and usually guarantees a strong profit margin. 

Similarly, for businesses with a declining gross margin, keystone pricing is a solid rule of thumb to follow because it automatically takes into account rising costs of production. If your production costs increase and the wholesale price follows suit, the markup of 50% always applies. 

A downfall of this method is the lack of outside research. If you don’t look at competitor pricing, you could be missing out on potential customers. 

Price skimming

This is a short-term strategy that only works for some businesses. Prices for new products are set high as they enter the market, and then subsequently lowered as customer demand is met and competition rises. Usually businesses with uncommon products or services will deploy this method. 

Competitors will see their high profit margins and make copycat products of their own, which leads the original business to lower its prices. Decreasing prices as the market becomes saturated is a good strategy because the original seller can remain competitive and appeal to buyers who weren’t willing to pay the original, higher price. 

Penetration pricing

Penetration pricing is the opposite of price skimming. It’s when products are priced lower than competitors to attract customers. These businesses aim to solidify their position in the market while growing their customer base with the help of reduced prices. 

For example, a new streaming service may offer the first month for free in order to appeal to consumers. Their goal is for customers to stick to the service and continue paying the regular price after the first month is up. 

Penetration pricing is often used by retailers that offer subscription-based pricing, such as spas and gyms. 

Price anchoring

Price anchoring is a niche but effective strategy. The goal is for businesses to make their target product seem cheaper or a better deal when compared to a more expensive offering. Customers will leave pleased about finding a good deal, and businesses will retain a handsome profit margin.

It’s more of a psychological strategy–businesses are nudging you toward their target service by placing it next to one that is more expensive and therefore less appealing to the customer. We’ve probably all been targeted with price anchoring at some point as shoppers. 

For example, if you were shopping for a camera and saw one that had premium features but was $2,000 versus the one beside it that had fewer premium features but was $1,200, you’d probably go for the latter. That would be intentional–they strategically placed the two together so that you’d compare them and decide you’re getting a better deal with the cheaper one. Choosing the less expensive camera may on its face seem like a loss for the company, but in reality, it’s the one they wanted to sell to customers all along!

Bundle pricing

Bundle pricing is used to group products together and price them as a single ‘bundle’. This can be used in all sorts of ways. Retailers may bundle one popular product together with less popular products in order to increase buyers’ incentives for purchasing. That way, inventory that’s difficult to sell is offloaded as part of the bundle. 

Bundles attract consumers who are looking for deals and discounts, so they’re a good strategy to use if you’re hosting a sale. Individual items are often only priced lower by small increments, meaning your profit margin will remain the same. However, bundles can have the flipside impact of being unappealing to customers who aren’t interested in buying multiple products at once. 

Brick-and-mortar vs ecommerce pricing 

Keep in mind that you’ll need to shift your approach to pricing across brick-and-mortar and ecommerce too. 

“We sell both in store and online and have found that our lower price point products sell better online versus our higher price point products, which sell more in person,” said Morgan Futrell of Moonshine and Magnolias, a family-owned boutique in North Carolina. 

• Remember shipping. Futrell also suggests similar businesses carefully plan how shipping costs can be included in pricing. “A $5 shipping cost will not cover the amount that it will cost to ship anything in a padded envelope, therefore this cost should be either included in the product price or result in a calculated shipping option,” she suggests. 
• Don’t spend profit to ship product. Take the items you will be selling online into UPS and have them price to ship. Then use that information to identify if you should increase prices, shipping rates, or minimum spends for any free shipping.

Yes, customers love free shipping, but offering it across the board may chip away at the effectiveness of pricing strategies.

How to select the right pricing method

There are a few things you should do when selecting your pricing strategy. Remember you can employ a combination of the methods we discussed depending on the outcome of these steps and the nature of your business.

1. Get to know (and listen to) your customer base

Research your customers and make sure you know your target market. You should know basic things like the average demographics of your customers, but also their past purchasing habits and any potential pain points. You can use this information to inform how customers will respond to changes in your pricing. How will they respond to changes in pricing? How have they received changes in the past? These are important questions you should be able to answer.

It’s also helpful to gather data straight from customers. Send out surveys asking them about their spending habits, how they’d respond to pricing changes, and more. It also shows customers that you care about them and are taking their desires into consideration. 

You should also calculate their Customer Lifetime Value, which measures the average revenue a customer will bring to your business throughout the course of their time purchasing. 

If you’re totally revamping your pricing strategy, create a buying persona, which is a detailed profile of your ideal customer. You can read more about this in our blog on how to build a brand. For medium to larger businesses with more consumer variety, create multiple buying personas. 

2. Determine your pricing and market potential

Market potential is a measure used to estimate the optimal number of sales you can expect from your product or service. It allows you to calculate the potential demand for your product or service specifically from your target market. 

Pricing potential is a general estimate of how much you can charge for products based on production expenses, costs and demand. 

3. Choose a price range

Your price range should fall somewhere between a minimum amount that still guarantees profit per item despite overhead costs, production and labor. The maximum price is the number you can charge without turning away new customers or isolating your current customer base.   

4. Conduct competitor research

This research isn’t restricted to competitor-based pricing. You should have a firm understanding of your competitors’ pricing habits. Find out what’s working for them and what isn’t so that you don’t fall into the trap of blindly following competitors. There could be areas where you could gain an edge pricing wise. 

Remember product value and appealing to customers are both important factors: you can choose to price your products lower than the competitors, but you can also appeal to those seeking better value and quality and communicate that to customers while setting prices higher. 

5. Account for your industry and brand

Your pricing strategy will change depending on the industry you’re in. Research the most commonly used and most well received pricing methods used in your industry. You’ll gain insight into what you could be doing better to stay ahead of competitors. 

Also, don’t forget your business doesn’t exist in a vacuum: your brand and business model are also important to consider when determining your pricing strategy. Depending on how customers perceive your brand (and your brand reputation) you can adjust your pricing as necessary. 

For instance, if a clothing retailer focuses on sustainability, customers may feel better about spending more on clothing that is ethically made. 

Pricing strategy examples

Let’s take a look at a few examples of the more common methods of pricing. 

Cost-plus pricing example

With rising production costs, Jenna wants to see if it’s feasible for her to raise prices at the pet store she owns since she doesn’t want to let go of any employees. She calculates her production, overhead and labor costs and uses the resulting numbers as a baseline for how much her products will cost. 

She calculates the costs associated with her products and then marks up the price to ensure the products are profitable without scaring away customers. This amounts to a markup of 55% to maintain her profit margins, an 10% increase from before her production costs rose. 

Competitor-based pricing example

Sameer owns a bike store with two locations in California. The area he operates in has several similar stores, all vying for the attention of athletic Californians in the area. Interested in pricing smartly, Sameer decides to research his competitors’ pricing habits. He researches their prices, customer reviews, inventory and more to determine how this will impact his own pricing. 

Ultimately he decides he edges out most of his competitors in the area of cycling shoes, which he has always advertised. He decides to slightly increase shoe prices relative to the average shoe price of his competitors, confident that his customers will recognize the abundance of choice and quality and choose to shop at his store for shoes. 

Penetration pricing example 

Delia owns a mid-range makeup brand in Los Angeles that she opened two years ago. Her team decides that cream blush is becoming increasingly popular among consumers, and works to launch the perfect affordable cream blush product. Delia notes that many of the products currently popular on the market are on the more expensive side, and decides to make her more affordable option part of the product launch branding. Her company is able to greatly reduce production costs due to their choice of packaging. 

Several months later, her brand launches the product after factoring in the production costs into the products’ price. To entice customers, her business promotes the quality of the blush at a more affordable price than most other popular options. Delia hopes to bring in her loyal customers as well as new customers who are looking for affordable alternatives to more expensive similar products.

Different retail product pricing strategies to test 

Experts have also come up with some clever ways to market pricing and make it appeal to customers’ emotions and instincts. 

Try psychological pricing

Professor Haipeng Chen is the Endowed Chair in Marketing at the University of Kentucky. He said good pricing is as much about hard, cold calculations as it is about how consumers feel. With this in mind, there are several psychological pricing tactics retailers can try, such as:

• Stacked discounts: Offer 20% off plus an extra 25% off, instead of 40% off. Stacked discounts like this look bigger. Therefore, you sell more without incurring any additional costs.
• Bonus packs: For example, offer 30% more at the regular price of $8.99/lb). “You win thrice. Consumers buy more. Thirty percent more looks bigger and better than a discount of 25% off. And it actually costs you less,” said Professor Chen.
• Price-ending of 99c. “You can sell more and make a bit more profit at $16.99 than at $16. To some consumers $16.99 looks better because 16 is easier on the eyes/mind than 17. To others, they realize the prices are basically $17 and $18 and 18 looks better. So rotate between the two to appeal to different customers,” he adds.

Professor Chen also suggests ‘hiding your treasure’, by showing smaller discounts first to lure consumers into your store, and once they are in, offer them bigger discounts. That increases their total spending, he said.

Encourage charitable donations

Instead of doing a deep discount (30/40/50%), a brand can instead use an incentive like 20% off plus 20% to give to a charity of your choice, suggests Andrew Forman, CEO of Givz, a platform that gives brands a way to convert discounts into donations. 

“We’ve seen this improve conversion more than 55% compared to 30 or 40% off offers. And consumers feel great about their purchase and the brand they purchased from, leading to higher retention and loyalty in the long-term,” said Forman.

Evaluating the success of the pricing strategy

Evaluating the success of different pricing strategies is difficult.  There are many factors in play. Here are just five of the ways to approach measurement.

Monitor sales volume and COGs

“We evaluate the quantity of the item sold along with the money on hand from each item,” said Futrell. “This helps us to evaluate what items are bringing in the most money for us, versus what items are selling the most. For example, we sell hundreds of small bracelets every month which is our top seller, however they are not our biggest money maker because their price point is so low.” 

Check conversion rates and retention 

Thomas Jepsen, CEO of Passion Plans, a house plans company, suggests retailers look at their retention and conversion rates to gauge your pricing strategy.  “Start setting up systems that look at how frequently customers are returning. Look at your product pages on your website and see what the conversion rate is over time as you’re trying out different strategies,” he said.

Compare the selling locations

Doing a controlled test can help you measure your pricing performance too. “One method would entail selecting a subset of selling locations and leaving the prices alone,” said Josh Pollack, of the Parker Avery Group. “If the hold-out stores are similar enough to the remaining stores, the difference between the performance of the price-changed items in the two sets of stores is due to the pricing activity,” he said.

Compare similar products

Measure the performance between items in the range, for an even more sophisticated method for evaluating price strategies. This is especially useful when a location comparison is inappropriate, according to Pollack.  This involves using statistical methods to compare the selling patterns of the price-changed items to all of the remaining items in the product range.  

Check gross margin and order size 

“The key metrics in retail are gross margin, conversion rate, average order size, and customer lifetime value. These metrics will show you if your pricing strategy is working well or not,” said Darren Litt, the co-founder of Hiya Health, which creates multivitamins for children. Tap into your POS data to understand these metrics. 

Getting confident with pricing 

Pick a pricing strategy that best fits your business. And don’t be shy about experimenting with different approaches, as you learn more about what works and what doesn’t for your retail store. To learn more about how Lightspeed can help simplify your approach to pricing, talk to one of our experts.