This article was originally published on May 27, 2019, and updated on April 28, 2021.
Knowing how to price products might seem simple, like just another task to accomplish for a business owner in the development phase. However, pricing a product is more than slapping on a price tag (or typing an amount into your ecommerce platform). It’s a complex process that affects the overall success and profitability of your ecommerce business, especially given the rollercoaster of a year we’ve had.
Due to the pandemic, the already burgeoning ecommerce industry went into overdrive. In 2020, U.S. online consumers spent $861.12 billion, representing a sharp 44% increase from 2019. According to eMarketer forecasts, there was 7.4 million new digital buyers in 2020 (both from younger generations starting to shop online and older, reluctant shoppers turning to ecommerce due to COVID).
There are about 1.3 million ecommerce websites in North America (U.S. and Canada), and 2 to 3 million in the world (excluding China). That’s stiff competition for new and established ecommerce businesses alike.
Beyond creating and marketing a unique product, pricing will play a critical role in customer perception. Scientific studies show consumers equate price with product quality.
As an entrepreneur, you need to determine an appropriate price that your target customer is willing to pay, matches the competition, and still yields a healthy profit.
Related: How to start an online store in 3 steps
How to price products: 7 competitive pricing strategies
Use the following steps to establish a competitive pricing strategy for your ecommerce business.
- Know your local competition.
- Understand the online market.
- Assess all of your costs.
- Determine your profit margin.
- A/B test your pricing strategy.
- Recognize the perils of underpricing.
- Consistently review pricing strategies.
Are you ready to gain the insight you need for pricing products? Let’s dive in.
1. Know your local competition
Whether you’re a new business pricing products for the first time or an established business reassessing your pricing strategy, competitor research is invaluable.
It may seem counterintuitive, but understanding your local competition is also important.
While an online store has a global audience, consider that people in your local area can look elsewhere in the community, or might have personal ties to smaller, locally-owned brick-and-mortar businesses.
Moreover, while the pandemic caused a surge in online sales, it also further changed consumer behavior in regards to local business. People wanted to support struggling members of their community during a challenging time. An Intuit survey confirmed this, finding 57% of Americans chose to shop small to keep money local and 38% wanted to support their community and local creators.
Additionally, 70% of consumers supported local businesses by shopping both their online and in-store offerings.
Today’s savvy consumer knows that ecommerce removes many of the hard costs of getting products to market, so they expect to see lower prices online. Take this into account when you research local brick-and-mortar competition.
2. Understand the online market
Just like knowing your local competition, being conscious of your digital competition is essential. Especially in this increasingly competitive ecommerce field. As Heidi Gibson, senior director of product management here at GoDaddy, told Fortune, more businesses than ever are turning to ecommerce options.
Do some quick, informal competitor research of similar products.
- Start a list or spreadsheet with your competitors’ price points. Make sure to notate product differentiators in relation to their pricing.
- What makes your competition stand out?
- What explanations do they give on their quality or unique characteristics that account for their prices?
- Alternatively, if you find bargain or discounted pricing amongst the competition, why might that be?
- Look at consumer reviews for real feedback, see if any mention price vs. value of the product.
Once you’ve accumulated a range of price points and competitor data, think about your product and your unique selling points (USP), and apply that to your pricing strategy.
Do you want to be a value player, a low-cost leader? Can you command a higher price than competition because of brand quality or features?
Keep in mind that it’s challenging to convert shoppers into buyers. As of the third quarter of 2020, the average online conversion rate hovered between 1.68% and 3.62% (depending on the device), according to data from Kibo Commerce.
In the saturated world of ecommerce, where competition is fierce, knowing how to price products in relation to the online market will increase sales and maximize profit.
Remember, your goal should be to model your competitors, not to copy them.
Use their pricing strategies as inspiration and then develop your own unique, product- and customer-based pricing models.
Related: How to find inspiration from your competitors (without stealing their ideas)
3. Assess all of your costs
When evaluating potential pricing structures for your ecommerce products, it’s essential to have a solid grasp on all costs associated with your business so that you can ensure healthy and sustainable profits.
In general, there are two types of costs:
Fixed Costs: These represent your hard costs that are unchanging; for example, the cost of hosting your ecommerce site, meeting payroll for any employees, leasing space for on-premise storage or offices and marketing. These are costs that do not fluctuate based on an increase in sales or production.
Variable Costs: These are costs that change based on production or sales volume. For example, your production costs might increase if you need more products, or perhaps the cost of materials lowers as your order more.
Make sure to take your time. It’s easy to miss expenses (such as services you pay for annually or quarterly).
Once you understand your fixed and variable costs, you can perform a break-even analysis (detailed in the next step).
Bottom line: You need to understand what it’s costing you to produce products and run your business, so you can accurately price products to sustain and maximize profits.
Related: Small business expense planning for your new online startup
4. Determine your profit margin
Profit margin is the percent revenue you make on each unit after you deduct your fixed and variable costs per product.
For example, if you set the retail price of your product at $80, and it costs you $60 to make, then your profit is $20, which represents a 25% profit margin.
Average healthy profit margins tend to vary by industry.
As an example, for clothing, it ranges from 4% to 13%, based on recent data.
To determine a realistic profit margin, first, do a quick break-even analysis. This is where you determine the number of sales you need to at least cover your costs. Consider your fixed costs for the business and the variable costs per product.
From there you can adjust your pricing strategy accordingly to determine a competitive, yet optimized profit margin.
Your pricing directly determines your profit margin, and this is where you’ll have to factor in all of your research and knowledge. There’s no sense in undercutting competitor’s pricing if you can’t make a return on your investment, or even worse, turn any profit.
5. A/B test your pricing strategy
If you want to try out a few different pricing strategies, test them against one another in real time.
A/B testing, aka split testing, usually occurs in web design or digital marketing, but you can also use this tactic to help determine competitive pricing strategies for ecommerce.
Simply use different pricing structures at the same time on your website and see which yields the best results (or most sales).
You can A/B test your pricing strategies in two ways:
- If you have any type of digital marketing campaigns that funnel traffic to your product landing pages (like PPC, social media ads or email marketing), create two landing pages with different pricing, and equally direct traffic to each. After a set amount of time, see which product has the best conversion rate.
- If you have different products of a similar nature and price point, you can test pricing strategies on each. Then track sales and see if one outperforms the others.
Stuck on which type of pricing strategies to test? Quickbooks recommends these standard pricing models:
- Pricing at a premium: Price products higher than your competition, then, market the value perception and unique features that constitute the premium price.
- Penetration pricing: Generally used for new businesses or products that can afford to offer a lower price tag to steal attention from competitors. You can label this as a low-introductory deal that will increase as time goes on.
- Economy pricing: Often difficult for smaller ecommerce businesses, this is basically setting prices low to attract the budget-conscious shopper.
- Price skimming: For new, unique products you set prices higher, initially. As other competitors enter the market or interest wanes, prices gradually decrease — the opposite of penetration method.
- Psychology pricing: Appealing to the emotion of a shopper by setting illusions of lower prices and better deals. For example pricing at $99 instead of $100, because customers might have a hard time spending past a certain threshold.
- Bundle pricing: The offer of lower pricing, or a deal when a customer purchases multiple products — a type of bulk discount. Bundling works well if you have complimentary products to pair together, you want to move a specific, low-selling product, or your variable costs decrease if you produce more items.
Depending on your industry, select pricing structures for your products and test a few against each other on your ecommerce site. Then make a data-driven choice, based on sales, to determine the best pricing strategy for your business.
6. Recognize the perils of underpricing
Something that may seem so simple, like how to price a product, is a foundational ingredient to your overall business health and viability. It’s essential to exercise caution when trying strategies like penetration or economy pricing, because in reality, you might be underpricing.
While it might be attractive to get the sales up front, underpricing can be dangerous to your ROI and bottom line.
Something else to consider: When you price products at the lowest possible point, not only are you diminishing your profit margin, but you also limit the possibility for adjustments.
What if you want to run a sale, or offer a discount? If you lowball your product, there’s no wiggle room.
What’s more, if you have a bargain basement perception, you won’t attract customers that value quality over cost. Recent data from the NRF shows that 32% of shoppers rank “highest quality item” as their most important purchasing factor (more than the 30% that say price matters most).
Online consumers are savvy digital natives that understand you get what you pay for.
Nellie Akalp, entrepreneur and founder of CorpNet.com, has cautioned that “even though you might land the sale, underpricing your products and services comes at a cost. … Entrepreneurship is challenging enough without feeling like you’re underpaid and overworked. Charging too little can not only put a damper on your revenue potential, but it can also douse your enthusiasm for your business.”
7. Consistently review pricing strategies
You can’t have a set-it-and-forget-it attitude when it comes to pricing products, especially in the constantly evolving world of ecommerce.
Business owners and entrepreneurs must consistently assess their data, metrics and pricing strategies to ensure optimal sales and profit. Moving forward, you need to consider cash flow, sales history and changes in the customer market.
Aim to review and update pricing strategies at scheduled times, like once per quarter. You won’t always need to adjust prices each quarter but rather when necessary. Alternatively, you may need to check prices more than that depending on industry trends. Refer to this checklist of events that should trigger reviews and/or changes in pricing structures:
- Your costs change, (due to a minimum wage increase, changes in the cost of goods or new tariffs introduced)
- The economy shifts (inflation or recession or a global pandemic)
- You notice that competitors change their prices
- You launch a new product
- You enter a new market or vertical
- You have a high-performing product (for example, you’re regularly sold out, or you receive a celebrity or influencer endorsement)
If any of the above occurs, use it as an alarm to stop and evaluate your pricing strategies to make sure they’re still effective.
How to price products to maximize sales and profit
Pricing products is not an exact science, and it’s not an art form — it’s a dynamic, business-dependent strategy that can be challenging for even seasoned entrepreneurs. With the boom in ecommerce due to pandemic-related changes also comes an increase in competition, as well as even savvier digital shoppers.
Your decisions will depend on your particular niche, goals, products, industry and other factors.
Know that you’ll need to put in the time to research your market and competition. Crunch numbers on your costs to determine pricing that can maintain long-term product profitability. Analyze current business metrics and A/B test strategies to gather more data to bolster your decision-making. Be cautious of underpricing.
Finally, once you set your prices, know that it’s a living, breathing process that needs to be monitored and nurtured as your business and the market evolves.
With dedicated product pages, you can go in and change the price as you work through your strategy.
This article includes content originally published on the GoDaddy blog by the following authors: Francine Hardaway, Nellie Akalp, Andrea Rowland and Steffi Chen.
The post How to price products — 7 competitive pricing strategies to make a profit appeared first on GoDaddy Blog.