Choosing your product’s optimal price is an extremely important decision that should be made as soon as possible. In general, if your product is priced too high then it won’t sell well. If your product is priced too low, you won’t be able to make a decent profit.
Charging too much or too little can be difficult for a startup to recover from. It’s especially hard to increase the price of your product after it has hit the market.
So, let’s look closely at the best way to price your product. Pricing depends on many variables, so start thinking about it even if you are just in the beginning stages of validating your product idea.
In general, err on the side of setting your price too high. This way you can drop the price if needed down the road.
But keep in mind, if you set the price so high that your initial sales are low, that can also be hard to recover from. Your best bet is to hit your ideal price early on.
What type of market are you targeting? Is your product for kids, cooks, scuba divers, cyclists? Is your product a luxury item with limited appeal, or does it have a broad market of consumers?
Let’s say you are developing a wireless fitness tracker. Is your wearable tech targeting professional athletes who want to pay extra for top of the line features? Or, is your product designed for general consumers who only want the simplest features and the lowest price?
Your price must reflect your customers’ demographics. So work hard to figure out who wants to buy your product.
Gather as much demographic data as you can about your targeted market. What is your target customer’s age range and income? What about their geographic location, gender, etc.? Asking these questions allows you to know who will buy your product.
Then dive deeper into the demographics to figure out why exactly someone is going to buy your product.
What is the best distribution strategy for your product? Your product’s price heavily depends upon the answer to this question.
For example, is your product for sale on your website? If you can sell your product yourself, you make a much larger profit than selling through retail stores. You can theoretically sell your product at a lower price, since your profit margin is greater without a retailer taking a cut.
But you absolutely, cannot forget that you will eventually likely move up to selling in retail outlets. You have to price your product as if it were for sale in retail stores even when you only sell it your own website.
Otherwise no retailers will want to carry your product because consumers can get it cheaper if they purchase directly from you.
You have to consistently sell your product for around the same price, regardless of where the consumer buys it. Your product price needs to remain consistent whether its for sale on your own website or in retail stores.
Some startups get around this by selling a different version of the product on their website. This product, which could have a lower price, will not compete with any of the retail stores carrying your higher priced product.
Eventually, you will be selling your product through multiple distribution channels. Some retailers only work through distributors, so you will need to factor in the percentage cut they will take.
You will also have sales representatives, that work for commission, selling to your larger retail customers. Their commission also needs to be taken into account.
When deciding on your price, consider all of these varied distribution channels.
Estimate Your COGS (Cost of Goods Sold)
To figure out your best product price, you first need to know how much each unit will cost to make. This calculation is called your Cost-of-Goods-Sold, or your COGS.
Consider this number your pricing floor. If your product sells for less than your COGS, you lose money.
You have to calculate exactly how much each unit of your product will cost to produce. If this number is too high, you won’t be able to sell your product for a profit.
You will need to add up all your costs. This includes the cost of manufacturing plus any “extras” that are required. How much will you need to pay to package and ship your product? Do you have to pay duties to export your product from Asia, and do they include any new tariffs?
When your product arrives in your home country, do you have to pay any import duties? Will you need to warehouse your product at any point?
Also keep in mind that your product’s COGS will drop once you increase your manufacturing volumes. For your early units the COGS will be so high that you likely won’t make any profit.
In many cases you will even need to sell your early units at a loss. That’s fine though, as long as you know you can achieve profitability once your production volumes are high enough.
If you need more detailed help calculating your product’s COGS, this previous article of mine describes every single cost associated with developing and manufacturing your product.
Don’t wait until your product is developed to estimate your manufacturing costs. It is imperative that you calculate your COGS before you invest time and money into developing your product.
Your COGS should include all of the following:
- Electronic components (sensors, microchips, connectors)
- Production of your Printed Circuit Board (PCB)
- PCB Assembly (soldering of components onto the PCB)
- All plastic parts including your enclosure (injection molded plastic)
- Mechanical components
- Product assembly
- Product testing/Quality control
- Scrap from manufacturing
- Manufacturer profit
- Customer returns
- Import and/or export duties and taxes
- Warehousing and logistics
It is hard for most entrepreneurs, even engineers, to accurately add up all of the costs mentioned above. This is why I started offering my hardware report service where I estimate all of these costs for your product.
Estimating these costs upfront allows you to know if your product can be profitable before you start spending big money on any development. If you can’t ever manufacture your product at a profit, its time to reconsider your product.
So let’s take a closer look, starting with cost-based pricing, at the three best strategies for determining your product’s best price.
#1 – Cost Based Price
COGS + Profit = Retail Price
You ideally want a retail price that is two to four times greater than your COGS. Also keep in mind that this margin may be lower for your first production runs.
But don’t go for the best pricing too early. The lowest price usually means producing large volumes of product. But you don’t want to order a large quantity for your first few production runs.
It is best to increase production numbers gradually. This will minimize your risks, which is most important at this stage.
This is because you will inevitably have bugs that will need to be fixed, in the product itself and in the manufacturing and assembly process. If you just manage to break even for your first production run, that’s okay as long as your margins increase at higher volumes.
You also need to take into account any competing products. Their price may put a cap on your price. A competitor already on the market will be manufacturing at high volumes that are reflected in their price. You cannot compete if your price is based only on your low volume production costs.
This is why your product price should be based on high volume production costs. Calculate your COGS assuming that you are at high volumes, since that will be your target goal.
Keep in mind that your cost-based price neglects two important factors – your competition and your customer. So let’s look closer at determining your market-based price.
#2 – Market Based Price
Determining your market-based price begins with researching your competitors. What are they charging for products similar to your own? Where does your product (and its features) fit into this market? Is it a cheaper or more expensive solution?
Your product obviously needs to be priced high enough to generate a good profit margin. But how will your price compete with a huge company like Apple?
Big companies are manufacturing at massive volumes, so they can keep their retail prices very low.
If your product is competing with a big, well known company, you won’t ever match their retail price. Instead, you must have new, innovative, unique features that make your product stand out.
Your market-based price is important, but it doesn’t consider your customers or your manufacturing costs. So, let’s get a more complete picture by looking at the final pricing strategy.
#3 – Value Based Price
You need to address your end consumer when deciding on your value based price. What value does your customer place on your product?
Suppose your product lowers your customer’s water bill. If your customer saves $300 a year, you could say that the product is worth at least $300.
But this doesn’t take into account the competition. What if they are selling the same type product for $150? You can’t ignore that. Instead, aim to stand clearly apart from any competing products.
So which is the better choice- market-based pricing, value-based pricing or cost-based pricing?
My advice is to consider all three strategies at the same time.
Step one is to calculate your COGS. Then, use it to calculate a cost-based price.
Step two is to multiply your COGS by 3 or 4 to get your market-based price. Assume that your manufacturing volume is somewhere around 10K. That will be high enough to get better pricing, but low enough to be realistically achieved.
Lastly, you need to figure out your most accurate value-based price. You want to determine if your product’s value to the customer is greater than the cost of your competitors’ products.
In simpler terms, your optimal sales price should be somewhere in between the cost-based price at the bottom, and your value-based price at the top.