How do you decide product pricing?

Product pricing is the direct factor that shapes your revenues and profits. Pricing a product involves decisions based on the value to the customers, cost to the company, and competition.

Here’s a step-by-step guide to pricing your product.

Understand value to customers

To calculate the value delivered by a product, you need to assess the benefit experienced by the customer to the cost incurred by them in getting the product.

1. Identify customer needs – Recognize what problem or pain point of the customer you are solving by the product.
2. Identify the key benefits – Recognize the features or parts of the product that are directly addressing the problem of the customer
3. Calculate tangible benefits – Identify how much tangible value the customer is gaining with the product. This can be calculated in different ways. For example – how much time is the customer saving with the product? How much revenue is the customer increasing with the product? How much cost is the customer saving with the product? In the end, everything translates to money. Calculate the total money saved or the total extra profit generated with the product.
4. Calculate intangible benefits – Along with the quantitive benefits, there can also be qualitative benefits with the product. Recognize such benefits. For example – how better has the user experience been with the product? How has the brand reputation increased of the customers by using the product? These qualitative benefits may not directly translate to monetary effects, but they do help in improving the efficiency or branding of customers.
5. Conduct cost-benefit analysis – Understand the cost the customer incurs in acquiring, adopting, and maintaining the product. This includes the direct cost spent and human resource costs. Compare this cost incurred by the customer to the actual benefits that the product is providing to them.
6. Calculate the return on investment – A customer (especially a business-to-business customer) purchases a product so that they expect to make a return on it after some time. With the cost incurred to the customer and the benefits the product is providing, calculate the time required to make the return on the investment made by the customer. This should be as little as possible.
7. Feedback – To understand the value to the customer better and make a stronger model of value delivered by the product to the customer, take feedback from customer success and support teams. Regularly assess customer feedback, usage data, and market trends to refine your understanding of the value delivered.

Understand the cost to your company

Accounting for all the costs is required to calculate the cost incurred by your company to develop a product. By development, I mean everything from research, development, marketing, sales, and support.

1. Salaries – Expenses on human resources is one of the major portions of the total cost for a company to develop a product. Salaries include the total compensation for all the teams like development, marketing, sales, and legal. This also involves payments to external contractors and experts.
2. Material costs – This is the total expenditure spent on the tools that enable various teams to perform their tasks efficiently. These include costs spent on things like software, devices, infrastructure, etc.
3. Overheads – These are the expenses spent on office space, utilities, and office supplies. These are the expenses that are directly not involved in the product development but are important to keep the company running.

Understanding the competition

In a competitive market, understanding the competition is an important part of deciding the pricing of the product.

1. Understand the competitive landscape – Identify the value propositions given by the competitors. Identify your differentiation and positioning in the market. The differentiator is the point you ideally should bank on. Emphasize features or benefits that competitors lack or don’t offer.
2. Understand the competitors’ prices – Know how your competitors are pricing their products. Understand whether are they conveying the pricing in the market.
3. Understand the pricing models – How are the competitors modeling their prices? What is the market trend in general? This is an important factor to know how your potential pricing model will be. In a competitive market, typically there are a couple of pricing models that the competitors have.
4. Customer feedback – Gather feedback on the perceived value by the customers using competitor’s products. Get to know about a general perception of their brand image in the customers’ minds.

Deciding your pricing

With the above points studied in depth, it is now the time to make an informed decision about how your pricing would be. Always remember the customer should perceive a value more than the cost they have incurred to get the product. The product pricing must cover the costs and profits.

1. Choose a pricing strategy based on your cost and profit expectations. These can be but not limited to –
2. Cost-plus pricing – Pricing based on cost and a fixed profit margin
   Value-based pricing – Pricing based on the perceived value by the customer
3. Competitive pricing – Pricing comparable to the pricing of customers

Remember in any case your pricing must always justify the value you are providing to the customer.

Choose a pricing model. This can be but not limited to –

1. Fixed pricing – Single pricing for all the customers
2. Dynamic pricing – Pricing based on the demand or customer segments
3. Bundled pricing – Pricing based on packages of products or features

After choosing the appropriate pricing and the model, continuously test what is working well and what is not. Based upon the feedback, iterate.