Pricing Strategies: Smart Prices for your Products and Services
Pricing your products and services can make a difference between profit and loss. When you think about pricing your products and services do not limit your thinking only to whether your price is low or high or your gross margin percent but think about the price point where you can maximize the net profit. This is your pricing objective. The price will drive the volume up or down and your net profit will change at each pricing level.
Mark-Up Pricing Model
Traditional pricing model uses mark-up percentage. This model takes into consideration the cost of your product or service and uses a mark-up percentage to calculate the selling price. For example if the cost of your product or service is $5 and you use 35% mark-up you will come up with the sales price of $6.75.
The difference between mark-up and gross margin:
Gross Margin is the gross profit percentage of your sales price and it is different from a mark-up percentage. In our previous example our mark-up was 35% or $1.75 however the gross margin percentage of $1.75 out of the sales price of $6.75 will be 25.92%.
Gross Margin Pricing Model
Many businesses use gross margin percentage pricing model. This means they have target gross margin percentage for all products or product categories and they calculate the target gross margin they need to make out of the total selling price or in other words gross margin out of the revenue. If we use the same example and the cost of our product or service is $5 and we want to use 30% gross margin then our sales price will be $7.14. The gross margin is 30% out of the sales price or $2.14. if we assume that we sell all products and services by using 30% gross margin that means that our gross margin will be equal to 30% of our total revenue. In most cases businesses sell more than one product and because of that you need to calculate your average or overall gross margin.
The two pricing models so far (the mark-up pricing and the gross margin pricing approaches) are pricing models based on cost only and they do not take into consideration the competitors’ prices, market demand, branding, marketing, etc. In other words you cannot really focus on pricing your products and services based on your cost.
Competitive Pricing Model
The competitive pricing model takes into account the competition and the marketplace. The most important questions here is “How much my competitors charge for the same or similar products and services?”. Other questions you need to consider are “How many people will buy my products and services at different price levels?” How strong is my brand compared to competitors? How effective is my marketing approach?…
As a conclusion, when you need to make important pricing decisions it is helpful to go over all these models and approaches back and forth and try to come up with the right prices for your business. Your competitive analysis will give you useful information but calculating your margin will help you decide if this is a profitable product or service for your business. Every business is different and what is profitable for one business might not be profitable for another. When you think about pricing also think about how you can improve thee way you sell and charge your customers as well as how can you improve your products and services in order to be more competitive.