13 February, 2024

How To Price Your Products and Optimize Profit Margins

There are things you can’t put a price on, like love, health, friends, and family. However, consumer product brands rely on pricing strategies to help drive sales. Whether you are a new business or introducing a new product, finding the right selling price for your products is crucial to winning customers, generating sales, and keeping your business profitable. 

We’ll walk you through the factors impacting pricing, how to price products, and tips to optimize your pricing strategies.

Factors to consider in pricing strategies

Many factors influence the pricing strategy you use for your brand, but the most common ones revolve around costs, profit margins, your competitors, how to get attention in the market, and your industry. 

For example, retail apparel profit margins average nearly 40%, while packaged foods average closer to 26%. So, companies using the same pricing strategy may see different margins if they are in different industries.

Cost of goods sold (COGS)

Cost of goods sold (COGS) is the total of the direct costs that go into producing or acquiring the items in your inventory. These costs include factors like raw materials, labor costs, shipping, packaging, wholesale inventory purchases, and warehousing.

For your business to be profitable, the prices of your products must be higher than COGS. While COGS is integral to all pricing strategies, it’s most commonly used in the cost-plus pricing method, where you calculate COGS per-unit and mark up prices to get your gross profit margin. 

This straightforward pricing method is prevalent with manufacturers, e-commerce brands, and retailers with well-defined costs for each product.  Since the average gross profit margin for retailers and e-commerce businesses ranges from 35 to 45%, a retailer with a $6 COGS for a product might price their product at $10 to get a gross profit margin of 40%.

Gross profit margin per unit (%) = (Selling price – COGS) / Selling price

($10 – $6) / $10 

$4 / $10 or 40%

Business owners with highly variable costs, like prepackaged food resellers where seasons change base prices for ingredients, will find this method more complex as it would require frequent price changes. Instead, they might use a combination of competitor pricing and brand positioning in pricing.

Competitor pricing

A competitive pricing strategy is one where you sell your products at a lower price than competitors. This strategy is best utilized when the market is price-sensitive, and consumers shop more on price than quality or brand name, such as groceries or office supplies.

Typical profit margins for this strategy vary and may fall below the average gross margin ranges seen in cost-plus pricing. One example of a brand that uses a competitive pricing strategy is Walmart, which has a gross profit margin of around 25%.

Brand positioning

Your brand’s reputation and positioning are crucial considerations in a value-based pricing model, where you set selling prices based on a product’s perceived worth to your customer rather than a markup based on COGS. 

Buyers for this strategy care less about the total cost than their idea of the product’s value. This method is often used by luxury brands or companies with products differentiated by quality.

While the average gross profit margin for luxury retailers is around 45%, some well-known brands realize higher margins based on their brand image. For example, LVMH (Moët Hennessy Louis Vuitton) profit margins commonly reach 68%.

Breaking into the market

If you’re new to a market, your pricing strategy often depends on whether you want to try to maximize sales volume immediately or target early adopters first. Penetration pricing and price skimming strategies start with an entry pricing position and then adjust for a maintenance pricing position.

Penetration pricing is a strategy where a new brand enters the market with low prices to gain market share and then increases pricing over time as a customer base is established. An excellent example of this strategy is SaaS companies that offer freemium versions of their product or subscription companies that raise prices after establishing a sizable customer base.

Price skimming is the opposite approach, where a brand enters the market with a high product price in an effort to quickly recoup development costs and lowers it over time. The goal is to attract less-price-sensitive early adopters first and then make products more accessible after demand increases. Technology products such as new smartphones, cameras, video games, and video game consoles often use this strategy.

Penetration pricing often results in initially low or negative gross profit margins but higher sales volume, while price skimming has higher profit margins with lower sales volume in the beginning. Over time, gross profit margins will typically trend towards a middle ground as your brand adjusts from the entry position to the maintenance position. 

Promotional strategy

How you plan to use promotions, deals, and discounts in your larger marketing strategy can also impact your pricing strategy. A promotional pricing structure works with other pricing strategies by offering a temporary price drop to generate quick increases in product demand. 

While promotions can boost sales volume, they also reduce profit margins. You want to be especially mindful when using a promotional pricing strategy with competitive or penetration pricing. These two methods already have lower profit margins, giving you less of a buffer for discounts. 

On the other hand, if you’re using a value-based strategy, frequent or steep price reductions can lower the perceived value of your products in the long term.

How to price a product for retail

For many product sellers, cost-plus pricing is a straightforward pricing strategy used as a base from which to build more complex pricing strategies.

Here’s a step-by-step tutorial to set your baseline cost-plus pricing.

Step 1: Calculate the cost of goods sold (COGS)

Start by calculating COGS for each item you sell. If you’re using Cin7, you’re in luck as Cin7’s inventory platform helps reduce human error and eliminates manual processes for you by automatically calculating COGS in real-time.

Step 2: Account for gross profit margin

Next, decide how much to mark up the item based on your target profit margin. Say you want to price an item with a COGS of $10 and a target gross profit margin of 30%. You can plug those values into the following formula to get your selling price: 

Selling price = COGS / (1 – gross profit margin)

$10 / (1 – 0.30)

$14.28

Step 3: Factor in overhead costs

Calculate fixed overhead costs to find your break-even point for sales volume. These are expenses that don’t change based on your sales and must be accounted for even if you sell nothing in a period. Examples include rent, business insurance, and utilities. 

Say your fixed costs are $6,000 per month. To calculate per-unit profit, subtract COGS from the sales price. Continuing with our example, your profit per unit would be:

 

Profit per unit = price – COGS

$14.28 – $10 

$4.28

Based on your per-unit profit margin, you can calculate how many items you need to sell to break even after overhead costs. 

Break-even sales volume = fixed overhead costs / profit per unit

$6,000 / $4.28

1,402 units per month

Step 4: Adjust pricing as needed

Experiment with different price points and profit margins to find the combination of expected monthly sales volume and price point that works for your business. For instance, if demand forecasting suggests a target sales volume of 1,402 units per month is too high, you can raise the price of your products to lower your needed break-even sales volume.

Tips to optimize your product pricing strategy

Once you’ve set prices for each product, here are some tips to optimize your pricing strategies for long-term profitability.

Know your customers

Some buyers are more price-sensitive than others. Still, understanding how much your potential customers are willing to pay for your products is vital. 

Market research helps you understand your target audience’s preferences and shopping behavior, enabling you to make informed pricing decisions. Specifically, if your customers are not price-sensitive, value-based pricing may be a better fit than a competitive pricing strategy.

Research the competition

In 2023, 66% of consumers switched brands because a competitor offered a better price. Even if you don’t want to compete on price, you still need to know what your competition charges for similar products so you can focus on other differences to justify a higher price.

If your prices are higher than your competitors, you can drive sales by highlighting higher quality levels or additional features your product offers.

Increase profit margins with Connected Inventory Performance (CIP)

You can boost your gross profit margin in two ways: increasing prices or reducing costs. Prices can’t be raised indefinitely without impacting your sales, so reducing costs is a more sustainable option. 

Connected Inventory Performance (CIP) uses automation to enhance operational efficiency and lower COGS, which enables you to increase profit margins without raising prices. Automation also helps you get more work done without increasing headcount, allowing you to save money and scale without driving up costs.

CIP helps reduce inventory inefficiency by enabling more accurate inventory counts, optimized warehouse logistics, and real-time COGS calculations that let you adjust profit margins on the fly.

With accurate stock levels and sales data from a specialized inventory management system like Cin7, you can adjust your pricing strategy to take advantage of fast-moving products and leverage discounts to sell slower products before they become obsolete.

Test price points

Prices aren’t set in stone and should be responsive to changing market conditions like:

  • Competitor pricing
  • Economic conditions
  • Cost of inventory
  • Market demand

Cin7 provides accurate real-time data on inventory and sales, making it easier to assess product performance at different price points to find the sweet spot that works for you and your customers.

Factor in promotions

Before pricing an item, analyze your profit margins at various discount levels, such as 10, 20, and 50% off, to determine an optimal price point. This helps you maintain profitability while offering discounts to increase sales when inventory turnover is slow.

In lieu of price discounts, offering perks like free shipping may increase sales since 47% of consumers abandoned carts because extra fees like shipping and taxes were too high.

While free shipping is a great way to increase demand, it can eat into profits because the seller absorbs the shipping fee. You could slightly increase prices to offset the additional cost or only offer free shipping for orders over a specific total. 

Utilizing CIP is an inventory management technique that reduces costs and helps create the margin buffer when offering free or expedited shipping as a competitive advantage.

How to price a product and optimize your profit margins with Cin7

Finding the right price of a product isn’t an exact science. However, having access to accurate, real-time data on inventory levels, COGS, and sales volume can give you a significant advantage in your pricing strategy. 

Leverage Connected Inventory Performance’s data-driven insights and operational efficiency to lower costs, boost sales, and increase profit margins. 

Experience Cin7 today with a free trial to take control of your inventory and grow your business. 

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