One of the most difficult aspects of selling products on online marketplaces is pricing. If you price your products too high, your sales volume can suffer, but if you price too low you can cheat yourself out of profit or even lose money.
I am going to explain some common methods for pricing products and explain what method I use and why.
Cost Plus Pricing:
Cost plus pricing is the simplest pricing model on this list. It is the pricing model that has been around generations and some sellers swear by it.
Cost plus pricing is exactly what it sounds like. You find out all the costs associated with the item or items you are selling, then apply a fixed margin so you arrive at a price at which yields a profit margin you deem acceptable. For example, you may buy a mug for $2.00 wholesale and decide that you need a 50% margin. This means that you need to sell this mug for $4.00 in order to achieve your desired profit.
Problems with this pricing model occur when selling through eCommerce marketplaces; it is never that simple. There are a lot of additional costs such as shipping, advertising, referral fees, etc. Many of these additional costs such as shipping and advertising are variable. Going back to my example we may have to sell this mug for $12.00 if we assume a $1.00 referral fee, an average of $3.00 in ad spend, and an average of $4.00 in shipping just to make our desired 50% margin. That doesn’t take into account any additional costs in regards to your margin. Not only do added costs that are often variable affect your ability to effectively use this model, but we have yet to discuss the biggest flaw of this pricing model:
It does not reflect competition in any way. It is blind to the rest of the market as a whole and can often lead to pricing that does not make sense when compared to other examples in the market.
Competition Based Pricing:
Competition based pricing is a subjective, yet effective method for pricing products. This method focuses heavily on the competition within the market to make sure your price is attractive given the other options available. To use this method you would simply look for a few examples of similar products with similar features to your own product to get a rough idea of what your product could sell for in a complex marketplace with diverse offerings. I find this to be a very effective method for setting the price of a new product when you need a starting point to test.
This method is great because the only data you need comes from your competitors, but there are drawbacks with this method as well.
Power of Brands
There are countless brands in the marketplace and it can be difficult to quantify the value of a brand. You can have an identical product to a major headphone brand, but your new brand of headphones will have difficulty competing with established industry players if you price similarly.
Sometimes the market will not turn out be what you expected when you purchased a product. In this case you may price in a range that loses you money due to steep competition.
The final issue is that competition based pricing is difficult to use with new or revolutionary products. If your product is something unique or you are the first to market there may be no similar listings to compare to.
Profit Maximizing Pricing:
The goal of every business should be to maximize profit so it would only make sense that your pricing should reflect that goal. The first key to understanding profit maximizing pricing is to understand the profitability formula. At the most basic level:
Profit = (Revenue – Costs) * Quantity
This means profit has two key parts the “price side” and the “quantity side.” If one side of this equation increases faster than the other side decreases, then your profitability rises. For example, if I sell 100 CDs that cost me $5, then at $10 each my profit would look like this:
Profit = (10-5) * 100 Profit = $500
Now what I can do is experiment with price cuts and increases. For example, let’s solve to see how many more CDs I would have to sell to justify a 10% decrease in my price:
$500 = (9-5) * Q Q = 125
This shows that I would have to increase my sales volume by at least 25 units or a 25% in sales to justify a 10% price cut. If I believe this is a reasonable expectation I could reprice my item and test my theory. You can also apply this method to price increases. For example, say I wondered how many less CDs I would have to sell at a $12 price point:
$500 = (12-5) * Q Q = 71.4
This shows that I should raise my price to $12 only if I thought I would lose less than 28 sales or experience less than a 28.6% decrease in sales velocity. If I believe this to be a reasonable expectation I could reprice my item and test my theory.
The profit maximizing method is by far the most superior pricing method, however, it is only possible with previous sales data. Another tip when using this method is to make small moves in pricing rather than big ones. This will give you more control over your profitability as well as make your price appear more stable to your customers.