How to price a product: a 5-step guide with worked example

Pricing is the single highest-leverage decision in any small business. A 5% price increase usually flows almost entirely to net margin. Here's how to do it without guessing.

The three pricing methods, ranked by sophistication

Almost every product gets priced using one of three methods. Sophistication isn't always the same as profitability — the right method depends on what you're selling and who you're selling to.

Cost-plus pricing: figure out your cost, add a markup, that's the price. Simple, widely used in retail and contracting, but ignores what customers are willing to pay.

Competitive pricing: look at what competitors charge for similar products, price at, above, or below. Common in commodity-like categories where customers comparison-shop.

Value-based pricing: figure out what the product is worth to the customer, price accordingly. Highest margins but requires real customer research. Used in software, services, and luxury.

Most small businesses use cost-plus by default. Most successful ones graduate to a hybrid: cost-plus as the floor, competitive as the benchmark, value-based for differentiated products.

Step 1: Calculate your true unit cost

This is where most pricing goes wrong. "Cost" isn't just what you paid your supplier — it's everything that scales with each unit sold.

For a physical product:

• Materials / wholesale cost
• Direct labor (the time to make, package, or prep one unit)
• Packaging (boxes, labels, inserts)
• Inbound shipping amortized per unit
• Quality control / returns allowance (typically 2-5% of revenue)
• Payment processing on the eventual sale (2.9% + $0.30 if you take cards)

For a service:

• Direct labor (your time or your worker's time, at full burdened rate including taxes and benefits)
• Materials and supplies consumed during the job
• Tools and equipment amortized per job
• Travel time and transportation

Add it all up. That's your true variable cost per unit. The number is almost always 20-40% higher than the obvious "cost of goods" figure.

Step 2: Set a target margin

Now you need a target. Pick a number that covers fixed costs and leaves profit, using industry benchmarks as a starting point.

Math: if your monthly fixed costs (rent, salaries, software, etc.) are $10,000 and you expect to sell 500 units a month, each unit needs to contribute $20 toward fixed costs. Add target profit per unit — say $5 — and you need $25 of contribution margin per unit. If your variable cost is $30, your price floor is $55.

Step 3: Sanity-check against competitors

Now look at the market. Find 5-10 competitors selling something similar. List their prices. You usually find three clusters: budget, mid-market, premium. Pick which cluster you're in based on your brand and product quality.

If your cost-plus floor lands above the budget cluster but you can't compete on quality with the premium cluster, you're stuck in the dreaded middle — too expensive for price shoppers, not differentiated enough for premium buyers. The answer is rarely to lower price; it's to reposition or to find a niche where your costs make sense.

Step 4: Test value at the high end

The single most underused pricing tactic in small business: just charge more. Not 5% more — try 25-50% more on a subset of products or with new customers. See what happens to conversion.

Common result: a 30% price increase causes a 15% drop in unit sales but a 10% increase in profit, because the costs follow units. The customers who leave are often the most demanding ones, so support load drops too.

This isn't theory; it's the most predictable finding in pricing research. Most products are underpriced by 10-25% versus what customers will actually pay.

Step 5: Build in price flexibility

Once you have a base price, give yourself room to maneuver:

• Tiered pricing: good/better/best at different price points. Most customers pick the middle, which lets you set it where you actually want them.
• Bundle pricing: combine products at a discount to the sum, but at a premium to the headline item. Bundles raise average order value and obscure direct comparison.
• Volume discounts: protects your margin on small orders while making large orders attractive.
• Promotional pricing: a planned annual sale window. Don't discount unplanned — it teaches customers to wait.

Worked example: a $50 candle

Sarah makes scented candles. She's been pricing at $25 because "that's what Etsy candles go for." Let's walk through better pricing.

True unit cost: Wax, wick, jar, fragrance, label = $6. Labor at 12 minutes per candle at $25/hour = $5. Packaging = $1.50. Etsy + payment fees on a $25 sale = $2.65. Shipping (she eats half) = $2. Total: $17.15.

Contribution at $25: $7.85, or 31.4% contribution margin.

Fixed costs: $400/month (workshop space, software, materials inventory). She sells about 80 candles a month, so each needs to cover $5 of fixed costs.

Profit at $25: $7.85 − $5 = $2.85 per candle. At 80 candles/month = $228/month. After self-employment tax, she's making less than $200.

If she raises to $32: Etsy/payment fees rise to $3.10. Contribution margin: $32 − $17.60 ≈ $14.40. Profit per candle: $9.40. At 80 sales/month: $752. That's 3.3x the profit.

What if sales drop 20%? 64 candles × $9.40 = $601. Still 2.6x what she made before.

This is what underpricing costs.

The bottom line

Good pricing combines cost-plus (your floor), competitive (your context), and value-based (your ceiling). Most small businesses set prices once based on gut feel, then never revisit. The single highest-leverage thing in any small business is a quarterly pricing review.