How to Price Your Products: A Two-Step Guide
Setting prices can be one of the most difficult tasks for an online merchant to manage.
Your prices obviously need to be high enough for your business to turn a profit. Otherwise, you won’t stay in business for long. And the higher you set your prices, the more profit you’ll make per purchase. But, you also can’t set your prices too high or you’ll scare away potential customers.
So, the question is: Where can you set your prices so they’re high enough to generate a good amount of profit per purchase, yet low enough to compare favorably to the competition and encourage more sales?
When setting your prices, it helps to have some context. As of Q3 2019, businesses in the “Internet, Mail Order & Online Shops” industry had an average gross profit margin of 39.91%.
But within the ecommerce industry, there’s a lot of variation. For one thing, smaller online stores tend to have a lower profit margin than larger online stores. There are many other factors involved as well, such as the types of products you sell and the demographics of your average customer.
Ultimately, there are two key steps involved with setting the best price for your products, which we will detail below.
Step 1: Determine How Much It Costs to Run Your Business
The first rule of pricing is you need to make sure you’re bringing in more money than you’re spending. To satisfy this rule, you must use measures such as cost of goods sold (COGS) and operating expenses (OPEX) to see exactly how much it costs to run your business. Only then will you be able to work out a sensible pricing strategy.
COGS refers to the amount of money it takes for you to produce your products. This is quite easy to find for products you source — the COGS is simply the wholesale price you’re charged by your supplier.
There’s a little more math involved for products that you make yourself. In that case, you’ll need to add up the cost of raw materials as well as the cost of labor used to make the products to calculate your COGS.
COGS are direct costs, and on top of that you’ll need to account for the OPEX of your business, which are indirect costs such as:
- Creating and maintaining your website, including a separate hosting fee for stores that don’t use a hosted solution such as BigCommerce or Shopify
- Rent and utilities for ecommerce stores that also have a brick-and-mortar presence
- Marketing (search ads, display ads, guest posts and internal blog posts for SEO, etc.)
- Customer support
- Legal fees
To see where you need to set the price of a product in order to break even, you first need to determine the COGS on a per-unit basis. Then, you’ll need to estimate how much your OPEX costs per unit and add this to the COGS per unit to find your break-even point. Keep in mind that your prices aren’t set in stone, so you can always adjust your estimates as more information becomes available.
Figuring out how much it takes to break even is just the starting point when it comes to your pricing. You then must decide how much you will raise your prices beyond your break-even point — and for that decision, you need to know what the standard is in your industry.
Step 2. See What Your Competitors Are Doing
Your business doesn’t exist in a vacuum. Depending on your service area, there may be dozens or even hundreds of other online stores that sell products similar to yours to the same pool of potential customers.
You can’t afford to set your prices too far above the break-even point, or else you’ll drive customers away to a competitor with lower prices. But how do you even know what prices your competitors are offering in the first place?
This isn’t always easy — some of your competitors might not post their prices publicly, instead requiring prospects to contact them for a quote. You’ll need to do some investigating to find these prices.
A CPE is an online tool that collects product information from participating retailers and makes it easy for users to compare product prices, shipping options and other details against each other. These tools are generally designed for consumers, but they’re also helpful for businesses researching their competition.
Once you discover where your competitors are pricing products that are similar to yours, you’ll know how high you can set your profit margin without going so high that you price yourself out of potential customers.
You should consider listing your products on CPEs as well. When a consumer has reached the point of using a CPE, they’ve likely already decided that they’re ready to buy. So, these platforms provide you with an excellent opportunity to find new customers.
Put Your Prices to the Test
No matter how much research you put into determining your expenses or evaluating your competitors, there’s no way to truly know how effective your prices will be until you try them out and see what happens.
It will likely take some experimentation to find the sweet spot between highly profitable and highly competitive. Sometimes, you’ll be surprised by what happens after you change the price of a product. It’s not always as simple as lowering the price leads to more sales and raising the price leads to fewer sales.
For example, lowering the price of a product may give visitors the impression that it's cheap and poorly made, resulting in fewer sales. Conversely, regardless of the actual quality of the item, raising the price can make people perceive it as rare or exceptionally well-made, resulting in more sales.
If you’re trying to improve the sales performance of a product and adjusting the price doesn’t have any effect, that’s a sign something else is the problem. For example, the design of the product page might be difficult to navigate. This can lead to a lot of lost revenue — if it takes longer than 15 seconds for a visitor to find what they’re looking for, they will probably back out and look for another option.
You should use an A/B testing tool to troubleshoot web design issues. This allows you to create a new version of an existing page, then compare the performance of the new version against the performance of the original version at the same time. That way, you’ll know for sure if the changes you made to a page gave you the result you were trying to achieve.
Adam Ritchie is a writer based in Silver Spring, Maryland. He writes about ecommerce trends and best practices for Shogun. His previous clients include Groupon, Clutch and New Theory.