How to price a product

Start with what one unit costs to have on the shelf, ready to sell. The pieces differ depending on whether you buy the product in or make it yourself:

This is a pricing cost, worked out to make sure the price covers everything. How stock is valued in your accounts is a separate question for your accountant.

business.gov.au's cost-based method adds a markup or margin on top of the full cost of making and supplying the product, with materials, labour and overheads all counted. Its own checklist for setting prices follows the same order.

1. Work out overheads per unit: total overheads for a period divided by the units you expect to sell in that period. The expected units must be above zero, and a cautious estimate gives a more reliable figure than a hopeful one.
2. Add that to the unit cost to get a full cost per unit.
3. Decide the margin the product needs to carry. To price from a margin, divide the full cost by what remains of the price after the margin, written as a decimal. What remains must be above zero, so the margin has to be less than the whole price.
4. If you work with a markup instead, multiply the full cost by the markup and add the result to the cost. Keep in mind that the margin on the finished price will be smaller than the markup.

Some businesses skip the overhead step and choose a markup large enough to cover overheads across all products. That can work, but check it against the overhead total from time to time, or prices can fall behind rising costs without anyone noticing.

A price built from cost is a floor, not an answer. business.gov.au suggests looking at competitors' prices for guidance, not to copy, and comparing features, quality and customer service as well as price. It also suggests showing the product to a sample of customers, asking what they value and what they spend on similar products, then testing different prices to see what sells.

Price sensitivity matters for products in particular: business.gov.au notes that demand for some products shifts sharply with even a small change in price. If the product offers customers something unique, its guide says a higher price may be possible than cost alone would suggest.

• Skimming: open with a high price for early buyers who want something new, then bring it down to reach more customers. business.gov.au says this helps recover development costs before similar products arrive.
• Penetration: start low to win customers and market share, then move to a normal or profitable price.
• Loss leader: sell one line below cost to bring customers in and make it up on others. business.gov.au cautions that, poorly managed, it can eat into profits.
• Premium: a higher price for luxury or exclusive products, where customers expect quality to match.

business.gov.au notes that strategies can be combined, and its worked example shows a business moving between them as competitors arrive. Whatever you choose, it suggests making sure you could explain the reason for it to a customer, partner or staff member.

Once you have set a price, business.gov.au points to the rules on how prices are set and shown:

• Every price shown to consumers has to be clear and accurate, and must not mislead.
• Showing more than one price for the same product means selling at the lower one, or withdrawing the product until the error is fixed.
• Comparisons such as was and now prices, or a rival's price, have to be truthful and clear.
• Some retailers selling groceries must display a unit price beside the product price.
• A recommended retail price can be suggested to resellers, but they can't be forced or threatened into using it.
• Setting prices together with competitors is illegal, and business.gov.au warns against selling below cost for a long period to push competitors out.
• For online sales, business.gov.au's glossary explains drip pricing: extra fees and charges must be shown at the start, not added as the purchase goes on.

business.gov.au's glossary describes a mark down as a promotional discount, a common way to move surplus or discontinued lines. Its inventory guidance suggests running a sale on slow-moving items once stocktake results show which lines aren't selling. Before you discount, work out what is left of the margin at the lower price, and check that the discount still covers your costs, as business.gov.au suggests.

Recheck the unit cost whenever a supplier changes its prices, track gross profit for each product line each month, and go over the whole price list at least once a year. The consumer price index (CPI), business.gov.au's cash flow guidance notes, is one way to watch how prices for some products and services are moving.