How to Price Your Products? A Science Backed Answer

Posted 5 years ago by Lina Vashurina, 붚죕쳔 Team

Pricing is桂one of桂the桂most important considerations for桂any桂business. How much you charge for桂a桂product directly affects how much you can sell. Getting the桂pricing right can result in桂massive revenue boosts.

In桂this post, we�셪l look at桂some strategies how to桂price your products using proven theories. You�셪l learn about pricing science, statistical models, and桂pricing optimization based on桂the桂psychology of桂pricing products.

What is桂Pricing Science?

To桂put it桂into a桂tweetable sentence, 혫pricing science is桂the桂use of桂statistical models and桂competitor analysis to桂create a桂pricing strategy.혬

Pricing science owes its origins to桂the桂deregulation of桂the桂airline industry in桂the桂late 1970s in桂the桂US. Airlines offer a桂non-perishable commodity桂�� seats on桂a桂plane. The demand for桂this commodity changes nearly every day. Post-deregulation, airlines quickly realized that they could make much more money by桂varying their prices 껸끅桂per demand. They hired statisticians to桂create complicated models for桂predicting demand and桂changing prices accordingly.

This is桂the桂reason why ticket prices keep changing depending on桂when you book your flight.

In桂terms of桂management theory, pricing science forms a桂part of桂혫yield management혬. It桂is桂an桂important enough aspect of桂business that .

Large businesses often have dedicated professionals whose sold job is桂to桂figure out the桂best price for桂the桂company�셲 products. To桂forecast demand, they use complicated equations that look something like this:

Terrifying, right? But 껸끅桂you�셪l learn below, getting the桂pricing right is桂crucial for桂your business. The good part is, you don�셳 have to桂resort to桂equations like the桂one above to桂get this right.

The Pricing Process

It�셲 a桂simple fact of桂economics: 껸끅桂prices go桂up, demand goes down.

Your job 껸끅桂a桂business owner is桂to桂find the桂sweet spot between price and桂demand.

This equation can be桂represented 껸끅桂a桂curve, called :

In桂this scenario, your revenue would be桂a桂function of桂Total Purchases 녔桂Price of桂Each Product. This can be桂represented 껸끅桂a桂rectangle on桂the桂graph:

The 혫sweet spot혬 between price and桂demand would be桂the桂largest rectangle you can draw within this graph:

Of桂course, this is桂an桂oversimplification, but you probably get the桂idea桂�� to桂get the桂pricing right, you need to桂find the桂median between price and桂demand.

Pricing Your Products: What Not 넨늡桂뛰늡

Most businesses follow a桂rather simplistic pricing process called the桂혫Three C�셲혬 of桂pricing. These are:

Cost: The total cost incurred in桂manufacturing the桂product. Price, thus, is桂cost +桂profit margin.
Customers: What customers are willing to桂pay for桂the桂product. Usually found out through customer surveys.
Competition: What competitors are charging for桂their products.

On桂paper, this sounds good enough. After all, if桂you take your cost, customers and桂competition into account, you should be桂able to桂arrive at桂an桂agreeable price.

In桂reality, this strategy fails more than it桂succeeds. Some reasons include:

Costs can change depending on桂availability of桂raw materials. They can also change depending on桂the桂scale of桂production.
Cost based pricing discounts the桂actual value you provide to桂customers. It桂also doesn�셳 take into account intangibles like brand value, customer demand, etc.
Your competitor might be桂underpricing its products to桂gain market share.
Customer surveys to桂determine prices are sketchy at桂best. What a桂customer is桂willing to桂pay theoretically on桂paper, vs. what they pay with actual money can be桂very different.

And so桂on. The tried and桂tested model seldom works. This is桂why you need to桂adopt a桂pricing strategy that takes customer psychology, statistical models, and桂demographics into account.

How to桂Choose the桂Right Product Pricing Strategy

뇟桂well-rounded pricing strategy would focus on桂several factors. Some of桂these are:

1.桂Adopt Demographic Based Pricing

뇟桂cost or桂competitor based pricing model fails because it桂does not take customer demographics, product value or桂brand value into account.

To桂combat this, adopt a桂demographic-based pricing strategy, i.e. pricing your products for桂your target users.

For example, if桂you were selling jeans to桂rich celebrities, you can charge hundreds of桂dollars per pair of桂jeans. Instead, if桂your target market was 20-something college kids, you would have to桂bring down the桂price to桂under $50桂to桂reach a桂respectable sales volume.

To桂make this possible, you need the桂following demographic data for桂your target market:

Average income: Higher income means higher price tolerance.
Gender:
Location: Upscale location equals higher disposable income (not very useful for桂e-commerce).
Education: . More educated buyers, thus, can be桂charged more.

You can quantify demographic factors by桂taking into account their impact on桂sales (say, if桂average income is桂over $100,000, income gets a桂factor of桂2,桂if桂less than $100k but over $50k, it桂gets a桂multiplying factor of桂1,桂etc.).

With this 桂you can use a桂custom formula to桂calculate the桂price. Obviously, this formula should be桂based on桂statistical analysis, but something 껸끅桂basic 껸끅桂this can work:

Price =桂(Cost of桂production *桂demographic factors) +桂profit margin桂�� customer acquisition cost.

2.桂Adopt Dynamic Pricing

In桂1969, Frank Bass, a桂professor at桂the桂Graduate School of桂Purdue University, for桂quantifying the桂adoption of桂a桂new product. This model, called the桂, gave a桂simple equation for桂how people come to桂use a桂product in桂a桂marketplace.

Without going all mathematical on桂you, this model essentially divides consumers into two groups:

Innovators: These are the桂early adopters who try out new product and桂tell others about it.
Imitators: These are people who start using a桂new product after it桂has already gained some traction, often after recommendations from innovators.

The number of桂innovators and桂imitators peaks after some time. Graphically, this can be桂:

You can apply this model to桂most successful products桂�� physical or桂digital.

For example, Facebook�셲 innovators were college students who first signed up桂for桂the桂service. Later, imitators jumped aboard when .

The question now is桂�� how does this model apply to桂pricing?

Even though the桂Bass Diffusion Model describes the桂adoption of桂new products, .

The idea is桂simple: you can maximize revenues from each customer by桂basing your price on桂a桂generalized Bass Model curve.

Graphically, we桂can represent it桂껸끅桂follows:

In桂other words, you can:

Price the桂product low-moderate to桂attract early adopters. Make sure it�셲 not too low, else you won�셳 be桂able to桂increase prices later, and桂will affect value perception among late adopters.
Increase prices once adopters have become accustomed to桂the桂product. Alternatively, you can increase revenues through cross-sells 껸꾈삣桂넵김끅깎깜깜끅.
Decrease prices later in桂the桂customer life cycle to桂increase customer retention

Thus, your prices are never truly static but keep on桂changing along with the桂customer�셲 journey.

This is桂a桂powerful concept that removes the桂pressure to桂get the桂price just right. Instead, it桂forces you to桂adopt a桂dynamic product pricing strategy that is桂dependent on桂customer behavior.

Simple, but useful.

3.桂Increase price inelasticity

, or桂PED measures changes in桂the桂demand for桂a桂product with changes in桂its price.

If桂the桂demand decreases with increases in桂price, the桂product is桂elastic.

If桂the桂demand remains the桂same regardless of桂price changes, the桂product is桂inelastic.

There are two methods to桂determine the桂price elasticity:

Survey a桂sample audience from the桂target market. Ask them how their purchasing habits change with price.
Study historical records to桂understand demand changes against price.

You can then calculate the桂price elasticity with a桂simple formula:

PED =桂%桂change in桂demand /桂%桂change in桂price

This usually yields a桂negative score (since demand typically goes down with price). For example, if桂you increase the桂price by桂50%, the桂demand decreases by桂100%. The PED, thus, is:

PED =桂-100桂/桂50桂=桂-2

In桂rare cases, demand remains the桂same or桂actually increases 껸끅桂prices increase. This either happens in桂a桂bubble, or桂for桂commodities such 껸끅桂oil or桂luxury goods.

How does elasticity affect a桂company�셲 pricing policy

Price elasticity essentially gives you an桂understanding of桂how customers will react if桂you increase your price.

This is桂a桂function of桂three things:

Scarcity: If桂a桂product is桂perceived to桂be桂scarce, it桂can command higher prices without a桂let-up 쓩꾈桂삣깎낼껸꾈삣.
Value: If桂the桂product delivers a桂lot of桂value (or is桂perceived so桂by桂consumers), you can increase the桂price without affecting demand.
Brand: 뇟桂brand perceived 껸끅桂a桂rare, luxurious or桂premium brand can command higher prices without a桂slip 쓩꾈桂삣깎낼껸꾈삣. In桂some cases, demand can actually increase with prices. Such products are classified 껸끅桂

Luxury products typically use brand perception, value perception and桂scarcity (real or桂artificial) to桂sell products at桂high prices.

One of桂the桂best examples of桂this can be桂seen with diamonds.

Diamonds are notably expensive and桂prized commodities. This high price tag comes from an桂assumption that diamonds are rare. Since there is桂very limited amount to桂go桂by, businesses are right in桂charging more for桂the桂product.

However, that diamonds are not only not 곶껸곶깎,桂.

Businesses that deal in桂diamonds, such 껸끅桂De桂Beers, are able to桂command top dollar for桂their products by桂creating artificial scarcity and桂aggressive marketing.

For instance, gifting engagement rings 껸끅桂a桂tradition was . Seeing the桂sharp fall for桂its product, De桂Beers launched an桂 that emphasized how diamonds are 혫forever혬桂�� like the桂bond of桂marriage. The campaign was successful, and桂a桂practice limited to桂a桂select group of桂people suddenly became the桂established norm across the桂country.

All this marketing and桂positioning has turned diamonds into a桂largely inelastic commodity. It�셲 prices have steadily increased:

At桂the桂same time, demand has followed a桂similar curve:

The diamond industry managed to桂do桂this by:

Controlling supply and桂creating an桂artificial scarcity of桂an桂otherwise abundant resource.
Improving the桂brand perception of桂diamonds by桂positioning them 껸끅桂혫forever혬 and桂a桂symbol of桂love.
Improving value perception by桂emphasizing the桂toughness of桂diamonds and桂their 혫heirloom혬 status (a桂strategy frequently used by桂watch brands).

This aggressive positioning has helped turn diamonds into an桂inelastic product where consumers have a桂high tolerance for桂price changes.

How to桂Position Your Product

As桂a桂small business owner you can adopt several tactics to桂position your product for桂higher prices (without affecting demand):

Focus on桂the桂craftsmanship involved in桂the桂manufacturing process. Watch brands do桂this phenomenally well. You can charge exponentially higher prices by桂becoming a桂Veblen product.
Price higher桂�� people often equate higher prices with better quality.
Tell a桂story about the桂product�셲 design, creation and桂origins. Storytelling has been . Retailers such 껸끅桂Woot and桂the桂J桂Peterman catalog do桂this for桂individual products. Others such 껸끅桂American Giant weave a桂story about the桂brand itself.
Get better product design. that better designed products are perceived to桂be桂of桂a桂higher value by桂consumers. Even if桂the桂function remains the桂same, better form can improve your sales.
Improve website design. 껸끅桂 for桂the桂product being sold.

Product positioning is桂a桂whole new topic altogether, but the桂above should give you some ideas to桂get started.

4.桂Follow Psychological Pricing Principles

Lastly, you can improve sales and桂conversion rates for桂your products by桂framing the桂prices based on桂consumer psychology principles.

There are a桂number of桂tactics under this category. Four such tactics you can use right away are:

I.桂Use 혫charm혬 pricing
Charm pricing involves ending a桂price in桂9桂or桂7桂instead of桂the桂nearest round number.

It桂is桂one of桂the桂most widely used pricing strategies. Studies indicate that customers tend to桂focus on桂the桂numbers before the桂decimal point when they read a桂price.

Thus, even though there is桂just a桂$0.01桂difference between $10桂and桂$9.99, customers are more likely to桂view the桂latter 껸끅桂lower priced than the桂former.

깝꾈桂닥껸낌넨, , a桂payment processor, shows that products that use charm pricing often sell 2녔桂more.

II. Increase prices marginally

If桂you must increase the桂price of桂a桂product, make sure that the桂changes are marginal but frequent. Customers should barely register the桂change. Jumping from $12桂to桂$15桂will trigger resistance. But gradually increasing price from $12桂to桂$13, then $13桂to桂$14桂and桂so桂on桂over 12桂months won�셳 invite 껸끅桂much scrutiny.

In桂experimental psychology, this idea is桂called . It桂is桂frequently used for桂product improvements (such that improvements are noticeable but not glaring), but can also be桂used for桂pricing.

III. Split price into smaller units

뇟桂great way to桂increase sales is桂to桂split the桂price into smaller installments. For example, instead of桂asking customers to桂pay $100, you can ask them for桂five installments of桂$20桂instead. Even though the桂actual price remains the桂same, customers perceive the桂latter to桂be桂smaller since it桂reduces the桂혫sticker shock혬 associated with the桂price.

This strategy is桂frequently used by桂subscription products that give discounts for桂annual plans, but frame the桂price in桂monthly, not annual billings.

This way, even though the桂customer is桂being billed annually, he桂perceive the桂price to桂be桂lower since it桂is桂split into smaller monthly payments.

IV. Separate shipping costs from the桂price

When pricing your product, it�셲 important to桂keep the桂shipping and桂handling costs separate from the桂main product price. Else, you risk customers thinking that the桂total cost is桂actually the桂product price.

For example, if桂the桂product price is桂$30, and桂shipping costs $10, offering $40桂껸끅桂the桂total price will make the桂customer believe that the桂product itself is桂priced at桂$40.

Most retailers follow this strategy. For example, Amazon clearly mentions the桂shipping and桂handling costs separately.

Conclusion

Getting the桂pricing right is桂one of桂the桂harder challenges you�셪l face in桂your business. By桂adopting scientific, data-backed pricing principles, you can extract maximum value from your customer base.

Key Takeaways

Use product positioning to桂increase prices without affecting demand.
Frame prices using psychological principles to桂maximize potential revenues
Base prices on桂demographic data.
Adopt dynamic pricing that changes along with the桂customer�셲 journey.

桂

About The Author

Lina is a content creator at 붚죕쳔. She writes to inspire and educate readers on all things commerce. She loves to travel and runs marathons.

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