If you manufacture and sell your own products, you will want to know the relation between the price you set for your product and the impact that will have on your product design and manufacturing processes. In other words, you will want to know how does pricing affect product decisions.
If you set your prices too high, you will turn away potential customers and have insufficient funds left to invest in new product development. You also risk pricing yourself out of the market with lower-priced competition entering your industry and offering a more affordable alternative to your product.
On the other hand, if you set your prices too low, you may still have a shortage of funds to finance future development. You may even find it difficult to cover overhead expenses like labor and raw material costs.
In this article, we will look at the most important ways in which pricing can affect product decisions.
5 Ways in which Pricing Affects Product Decisions
- Pricing affects Product Design
- Pricing affects Production & Manufacturing decisions
- Pricing affects Inventory decisions
- Pricing affects Packaging & Shipping decisions
- Pricing affects R&D and New Feature Development
How Pricing affects Product Design
During the product design phase, you will make decisions about which design elements, features and functionality to include in your product.
These decisions will determine the value that your product will bring to a potential customer.
But will the customer be willing to pay for this value? And how much?
In short, how should you price your product so that you can justify the design decisions that you will make in the product design phase?
When it comes to pricing, there are two main schools of thought: cost-based pricing and value-based pricing.
Cost-based pricing is based on the cost of producing and delivering the product to the customer. This approach will typically lead you to a lower price point because your objective will be to cover your costs and make a profit.
Value-based pricing, on the other hand, is based on how much your customers are willing to pay for the product. This approach will typically result in a higher price point because you will be looking to capture more value from your customers and maximize profits.
Value-based pricing we’ll give you greater financial freedom while making product design decisions.
So, you will need to decide which of these two strategies will work best for your business while balancing product designs decisions, price and the customer’s willingness to pay.
How Pricing affects Production & Manufacturing decisions
Once your product’s design is ready you will need to figure out how to get it manufactured.
Should you manufacture in-house? Or should you outsource?
If you decide to outsource, should the outsourcing partner be an ODM or an OEM? Which one’s best for you?
If you manufacture in-house, should you invest in state-of-the-art equipment or settle for used equipment?
Can you afford to hire employees?
If you intend to produce the majority of your own products, you’ll likely need skilled employees who can use the machines and equipment.
If you decide to outsource, should you near-shore or should you off-shore?
To answer all these questions, you will need to know your product’s pricing, if customers will be willing to pay that price, and how many units you will sell. In short, your product’s price will affect your production and manufacturing decisions.
How Pricing affects Inventory decisions
The main goal of holding inventory is to ensure that you always have the optimal amount of stock on hand to meet sales demand.
But inventory is a cost and it’s bad to have too much inventory because your money is going to be locked up in this inventory. This can be especially dangerous if your product is seasonal because if you don’t get rid of your inventory before the season is over, you are going to have a lot of dead stock on your hands.
But having insufficient stock is also not ideal as you could lose out on sales.
But what is the optimal amount of inventory to avoid overstock and understock situations?
Well, your product’s final price can be a factor in your inventory decisions.
If you use a cost-based pricing model with lower profit margins, then a larger percentage of your product value will be stuck in inventory.
On the other hand, if you use a value-based pricing model, you will have higher profit margins and so for the same inventory levels, a lower percentage of your product value will be stuck in inventory.
Let’s take an example.
Let’s say you make widgets.
It costs you $80 to design, manufacture, store and sell a widget.
With a cost-based pricing model, you decide to charge your customers $100 per widget to get a profit of $20 with a profit margin of 20%.
Let’s say you decide to keep 100 widgets in inventory. This means you will have 100 widgets X $80 = $8000 of costs stuck in inventory.
The customer value of the products in inventory is 100 widgets X $100 = $10,000.
So, $8000 out of a value of $10000 is stuck in inventory. In short, 80% of your products’ value is stuck in inventory.
With a value-based pricing model, you may decide to charge $150 per widget to get a profit of $70 at a profit margin of 47%. Customer value in inventory is now 100 widgets X $150 = $15,000.
So, with 100 widgets in inventory, you will now have $8000 out of $15000 in inventory -or only 53% of your products’ value is stuck in inventory.
This example shows how your final price can have an impact on how much inventory you decide to hold. But note that this is just one factor. In the end, you will need to hold as much inventory as you need (and you can) in order to meet customer demand.
How Pricing affects Packaging & Shipping decisions
You need to consider how your products will reach the end customer and what will be the corresponding packaging and shipping costs.
Will you ship your products in bulk to various stores? Or will you ship them one by one to customers who buy them on your online store?
If shipping and handling fees are expected to be too high, you may want to consider raising prices to make up for these additional costs.
Conversely, if you find that you can charge more for your products than originally anticipated, you may want to lower the price of shipping and handling or make shipping free altogether to make the product more attractive.
One way or another, your product’s final price needs to include the packaging and shipping cost overheads. Whether to make these a separate line item and visible to the customer or include them in the product’s price is a decision you’ll have to make.
How Pricing affects R&D and New Feature Development
Your ability to invest in research and development for the future as well as in new features and functionality is directly linked to the amount of free cash flow that you can generate from your business.
In turn, your ability to generate free cash flow is directly linked to sales volume and profit margins which are largely impacted by how you decide to price your product.
If you price your product too low, you may not generate enough profits to be able to finance research and development activities and fund future growth. If you price your product too high, you may not sell enough and still fail to generate the needed profits.
So optimal pricing to maximize profitability will have a direct impact on your ability to invest in the future including in new features as well as in research and development for future products.
Summary
Pricing is an important factor for any business, and it can affect a number of decisions related to other parts of the business.
The price point at which you sell your product will have a major impact on the type of customers you attract, the revenue that you generate, and the profits you will have leftover to invest in the future.
Your price structure will impact how you design your products, how and where you manufacture them, how much inventory you hold, how you package and distribute your products, and how (and how fast) you develop new products.
So, price your products with care. Research the market and see what price points will be acceptable. Try out different price structures and see what works. And speak to others in the industry including your potential resellers, distributors and partners.
Thank you for reading and we hope you found this article useful 🙂
