Pricing to profit

The simplest way to price is cost plus pricing.  That is, determine how much it costs you to provide your product and add some factor.  A company that supplies to a department store may do a factor of four to the final consumer.  For example, it costs company X to $25 to make a product.  They may sell it to a department store for twice that, $50, and the department store my price it to the final consumer at $100.  Of course little things get in the way of that like promotional strategy.  Department stores are heavily promotional so they may price the product at $200 so that they can sell it to you at 50% off.  Cost plus pricing requires that you have done your market research on which features and functions the consumer requires.  Otherwise you may double the cost of the product and therefore the final retail by adding features the consumer is unwilling to pay for.

Cost plus is simple and it guarantees your products will make a similar margin percentage but it isn’t the most profitable way of pricing your product.  A better method is pricing to what the customer is willing to pay.  For example, working with Swarovski, I priced a foot tall pure crystal bird sculpture (which would have pricing according to Swarovski’s pricing methodology at $650) at $885.  I knew that the consumer would be willing to pay more for such a majestic piece.  What also helped my pricing decision was that I knew the product was supply constrained.  That is, we were likely to not be able to satisfy all of the consumer demand.  Therefore, Swarovski’s profitability was maximized by raising the price where demand would equal supply.

The goal of pricing is to price to the PROFIT maximizing level.  I stress profit because too many people attempt to maximize sales.  Let’s use a simple example.  Through analysis, you feel that you could sell 1000 units of a product at $10, 500 units at $15 or 250 units at $20.  Sales in these examples would be $10,000 at $10, $7500 at $15 and $5000 at $20.  If the product cost you $9 to make at $10 you would only have made $1000 in profit.  At $15, you would have made $3000 and, at $20, you would have made  $2750.  Therefore, pricing to maximize sales would have you at $10 while pricing to maximize profits would have you at $15.


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