How to price a product or service

Business owners know that how they price their products or services impacts profits — but some can find it’s a bit of a guessing game. How much a product or service is truly worth is dependent on what customers are willing to pay for it. Finding the right balance can be as much an art as it is a science. 

While there are always many gray areas, understanding how to price a product is worth learning. “Many businesses don’t spend a lot of time focusing on pricing, and as a result there is often significant financial opportunity they could realize from better pricing,” says Rafi Mohammed, author of The Art of Pricing and founder of Culture of Profit, a consultancy based in Cambridge, Mass. that advises businesses on their pricing strategies.

Here is an overview of some important things to know about pricing, including how to price your product or service competitively, different pricing strategies, factors to consider such as how much it costs to produce your product or service, techniques for adjusting your pricing as needed, and how to avoid common pricing pitfalls.

Why pricing matters

Pricing is how much you charge customers for your product or service. Many business owners opt for what is known as product pricing, which considers three factors to come up with the ideal price — the costs to produce a product or service, customer demand and what customers are willing to pay.

Although pricing may seem like a simple decision, it can be complex. It’s worth putting in the time to get it right because it can have a big impact on your profitability, market position and customer perception. Mastering pricing from the outset can help put your business on a strong footing for growth, and knowing how to adjust your pricing to reflect what you’ve learned through experience or changes in the marketplace can help your business continue to grow and thrive.

“Pricing is probably the main lever that business owners can use to improve their marketing, sales and ultimately profits — and it’s totally under their control,” says Jonathan Stark, a pricing strategy consultant based in Providence, R.I. “Just changing the price today can have a huge impact on profits.” 

Understanding your costs

When you price your product or service, it is important to tally all your costs to create it. There are two types of costs to consider: fixed costs and variable costs. Fixed costs are those that are consistent from month to month, such as salaries, rent for a production facility or office and business insurance. Variable costs, which change from month to month, may include raw materials or supplies that fluctuate in price, the utility bills for your workplace, credit card fees or advertising costs. You’ll also need to know how many units of a product you are producing or how many hours you are spending to deliver a service so you can determine what it is costing you.

To calculate the total costs per unit of producing your product or service, you can use a simple formula: Cost per unit = total fixed costs + total variable costs divided by the total units you are producing or delivering. Your results will be as accurate as the data you’ve gathered on what you are spending, so make sure you’ve included all costs.

Let’s say you manufacture board games. You might factor in fixed costs like rent for your factory, employees’ pay and benefits and business insurance, along with variable costs, such as electricity and heat for the plant, materials to make the boards, pieces for the games and boxes, marketing efforts such as maintaining an e-commerce website, and fees for advertising on Amazon and Instagram. You’ll also need to know how many game units you produce in a month to plug that number into the formula.

If you are a self-employed consultant who works from a coworking space, you might factor in fixed costs such as your salary, the rent for the coworking space and a paid subscription to a video conferencing service such as Zoom or Microsoft Teams. Variable costs might include unreimbursed travel to clients’ offices, developing marketing brochures and occasional networking event fees. For the total number of units, you might determine how many hours you spend serving customers each month.

Once you know what your cost per unit is for one month, you can multiply that by 12 months and come up with an average. That will allow you to account for seasonal fluctuations, like slowness during the summer or a boost in holiday sales. 

Generally, you will want to make sure that your total costs per unit do not exceed what you are bringing in. However, in a business with a high initial investment, it may take a while, perhaps six months to a year, before you get to that point. If your costs consistently outstrip revenue in a more established business, you may need to charge more so your business does not experience a cash-flow crunch or end up with heavy debt. 

Market research: Determining your competitive landscape

Whether you’re selling a product or a service, it’s important to understand who else is competing for your customer’s purchase. That means doing market research.

For a product-based business, check out online directories of local merchants in your category and identify online stores that might be competitors. If you run a service business, look at marketplaces of similar professionals. For instance, a freelance marketing consultant might search for their own title online or on a career site to see whose profile rises to the top. Take note of how your competitors are describing their services, the image they convey through details like their copywriting and visuals, how they package their services and what they’re charging. If there is a lot of competition in your market, it may be worthwhile to conduct a competitive analysis. 

In doing your market research, it is important to gauge what customers are willing to pay. Look at the range of prices your competitors are charging. One good source of data on what consumers are spending on common purchases is Numbeo, a cost-of-living calculator. It will tell you things like the average cost of a cappuccino, a loaf of bread, a pair of jeans sold at retail, rent for a three-bedroom apartment and other similar data for the whole country and in major cities. However, some markets, such as tourist destinations, may have their own pricing customs and may be too small to show up in a tool like this. In those cases, shopping at competing businesses or talking with other owners in a local chamber of commerce or networking group can give you insights into local pricing.

Generally, you’ll want to keep your prices in the same range as competitors. If your prices are much lower, and that savings can’t be attributed to your discovery of an ultra-efficient production method, you may have overlooked some of your costs in calculating your final price, such as your own labor (see “Calculating your break-even point” below). Take a close look at what you’re spending and make sure you’re factoring in commonly overlooked costs, like your own labor as the business owner, so you’re not just breaking even.

If you want to charge significantly more, you’ll need to find a way to explain to customers why what you’re selling is worth the higher price. You may convey that by offering a more luxurious setting for a shop or restaurant or by detailing how it is different and unique on your website and in your marketing materials.

You might also consider strategies such as bundle pricing, in which you sell a suite of products customers need — such as shampoo, conditioner and styling gel — for one price. Many consumers will value having products that work well together.

Different pricing strategies for business owners to consider

Understanding the most common pricing strategies can help you find a method that is a good fit. Here are some pricing strategies to consider.

Value-based pricing

In value-based pricing, you set your prices based on perceived value. In a product business, this means pricing goods based on the benefits they bring to the customer. In a service business, it is based on the customer’s desired outcome and the value of your contribution.

Value-based pricing should always be used by all businesses – not just the ones who can afford to compete on price with bigger competitors who have better economies of scale, according to Mohammed. However, it puts the onus on the business owner to know, or find out, what’s better about what you have to offer so you can emphasize that in your marketing. “The key to better pricing is to think like a customer,” Mohammed says.

What if your offering isn’t as high-end, advanced or elaborate as the competition? You can still use value-based pricing, Mohammed explains. “Price is a great equalizer, and this is all about having confidence in the value that you offer,” he says. “You can look a customer in the eye and say, ‘We aren’t as fancy as the other alternative that you’re looking at. We don’t have all the bells and whistles. But is that product really worth a 35% premium over what we’re charging?’”

Cost-plus pricing

This method of pricing your product or service adds on a percentage of the total operating and production costs to arrive at the final price. The advantage of cost-plus pricing is that it keeps you focused on your profit margin — the difference between what it costs to make and market goods and what they sell for. Make sure to review how to calculate your break-even point if you’re considering cost-plus pricing (Learn how below).

The downside of cost-plus pricing — and one reason experts sometimes discourage new businesses from using it — is that it isn’t rooted in what gives you an edge over your rivals and can leave you vulnerable to price wars. “It makes you look the same as everyone else and allows your clients to treat you as a commodity,” Stark says.

Beyond that, it doesn’t sync up with how customers typically think about pricing. “No one enters a big-box store and looks at a 60-inch television and says to themselves, ‘The most that I’m willing to pay for this television is 235% of what I think it cost to manufacture it,’” Mohammed says.

Competitive pricing

In competitive pricing, your prices depend heavily on what your market research reveals your rivals are charging. Typically, this means discounting your prices to get an edge.

The disadvantage is that by winning customers this way, you might actually lose. There is a fine line between pricing aggressively and getting caught up in a race to the bottom, where you are competing with rivals with prices so low that your business is unprofitable and unsustainable.

A good rule of thumb, according to Stark, is to avoid becoming the lowest- or second-lowest priced alternative and to focus on customers who are looking for what truly differentiates you, even if they are sensitive to prices. He advises asking yourself, “How can I fill a gap clients can’t fill any other way and look different to them?” he advises.

Premium pricing

Premium pricing is likely what you’ll use if you offer a high-end, exclusive or heavily customized product. It reflects the quality of what you sell, the time and craftsmanship that goes into it and the cachet of your brand — and sometimes the sky can be the limit when it comes to pricing.

However, premium pricing can put pressure on startup businesses to deliver the best quality and buying experience on a shoestring budget. And, contrary to what you might expect, it is not always the most profitable approach. Premium clients may demand customization, meetings and on-site visits that can cost you a lot of time.

Calculating your break-even point: Your path to profitability

When it comes to pricing, it’s important to understand your break-even point, or when you start to turn a profit on the items you sell.

To calculate your break-even point, first determine how much you make on every item or service you sell. Subtract the cost of producing it from what you sell it for to determine your gross profit. For instance, if it costs you $10 to deliver a product or service and you sell it for $20, your gross profit is $10. Then calculate your fixed costs — what you spend every month on office, rent, utilities and other overhead. Divide your fixed costs by your gross profit. Say your fixed costs are $2,000 and your gross profit is $10. You would need to sell 200 units to get to break even. There are many calculators online that can help you do this.

One mistake many owners make is forgetting to include the cost of their own labor. “When you think about how profitable your business is, I tell business owners to think of themselves as two different people,” Stark says. “They are the business owner who should be getting profits from that business, and they are also the main employee who's going to get paid.” You will get an accurate picture of whether your pricing is profitable only if you take these figures into account.  

Adapting your prices for different markets and segments

For many small businesses, it pays to adjust pricing to reflect local market conditions. For instance, if you do business in a lower-cost market and are pitching business in a higher-cost one, you may want to raise your prices in that market, where the costs of doing business may be higher and your brand image may suffer if you charge too little. This applies whether you are doing business within the U.S. or internationally.

What is more difficult is going after business in a market where competing businesses can charge much lower prices. If you do business in an area where labor and real estate costs are relatively high, it may not be worthwhile to discount your services to enter a new market. You might opt for a premium pricing strategy in which you target a small segment of that market or find a local partner who can deliver your product or service more cost-effectively.

Techniques for monitoring and adjusting prices

If you offer a service, it’s possible to monitor pricing in your industry by checking out talent marketplaces to see what the going rates are and by networking with industry peers who may not do business on those platforms. For product-based services, there are many industry-specific tools and software programs that can help. Ask for recommendations from industry peers and bankers for one that suits your industry and check out the website of your trade association to see if it has partnered with any software providers.

Avoiding common pricing pitfalls

Pricing is both an art and a science, and most businesses will make some mistakes. Here are some common ones.

Underpricing: This is very common among new businesses; the owner may not fully understand the competitive landscape or the complete cost of a product or service. Some service providers underprice because of imposter syndrome, where they don’t feel they deserve the highest fees because of lack of confidence.

To avoid underpricing, keep your eye on what competitors are charging and, if most are charging more than you, do some digging. Assuming you haven’t found a great new method to reduce your fixed costs — such as using artificial intelligence for a once-laborious process — you may be overlooking a critical factor in your pricing, such as labor costs.

Overpricing: It’s natural to want to get paid well, but to charge more you need to make a strong case that what you’re selling is worth more. That applies to your marketing and branding efforts, the quality you’re delivering, and the buying and follow-up experience.

If you’re not able to find many takers at your current prices, try experimenting with different pricing models — perhaps by offering a temporary discount — to see if those change anything. Alternatively, you may be pitching the wrong customers or selling your product in a market where customers are more price conscious. Doing some additional market research can help you get to the bottom of whether your prices are too high.

Essential tools and resources for pricing your products

There are dozens of tools available online to help with pricing analytics, managing prices across multiple sales channels, optimizing pricing and re-pricing items based on changing market conditions, and a variety of other functions. Some are add-ons to e-commerce platforms such as Shopify or specific to merchants on platforms such as Amazon.

Many of these tools are industry specific, so ask around in your industry for recommendations. Sign up for a trial of any tools you plan to use to make sure they’re user-friendly.

Also avail yourself of market research reports. Some research firms, such as Statista, offer free versions of more elaborate reports, which can get you started if you’re on a tight budget.

Once you’ve used tools like these to come up with ballpark pricing, experimenting in pricing can lead to innovation in how you package and price your services, says Stark. For instance, a plumber who normally charges fees for fixing a clogged drain or broken pipe might consider adding a subscription service, offering landlords and customers who own vacation rental properties unlimited routine services for a $100 a month. Multiply that by just 150 customers who sign up, and it’s $180,000 in revenue per year. A consultant who is charging $250 for an occasional weekly session might be able to encourage clients to sign up for a monthly retainer by discounting the per-session fee if they select this option. The key, Stark says, is to ask yourself, “How can I look different to customers and fill a gap they can’t fill any other way.”

Make sure you keep data on your experiments so you know which ones are working best and would be worth adding to your ongoing offerings and which ones are not as profitable as you hoped. 

The bottom line

Investing time to find the right pricing strategy is crucial to a business’s long-term success. The balance between value and profit can transform your financial outlook. Even a small adjustment in pricing can significantly impact revenue, making it easier to achieve profitability and reinvest in growth. The right pricing will not only help drive a business forward but also ensure sustained success and development.