Pricing is one of the highest-leverage decisions in any business. A 5% improvement in price has a larger impact on profit than a 5% improvement in volume or a 5% reduction in costs. Yet most small businesses set prices by guessing what feels acceptable or by copying competitors, without a systematic approach.
Method 1: Cost-Plus Pricing
Cost-plus pricing starts with your costs and adds a desired markup.
Selling price = Total cost per unit × (1 + Markup percentage)
Example: a product that costs $25 to make, with a 60% markup:
Selling price = $25 × 1.60 = $40
Cost-plus is simple and ensures you cover costs, but it has two weaknesses. First, it ignores what customers are willing to pay, so you may underprice (leaving money on the table) or overprice (making yourself uncompetitive) relative to market expectations. Second, it requires accurately knowing your cost per unit, which can be harder than it sounds when fixed costs are allocated across multiple products.
Method 2: Target Margin Pricing
Similar to cost-plus, but expressed as a margin instead of a markup. The formulas are related but different:
- A markup is a percentage of cost
- A margin is a percentage of selling price
To price for a specific gross margin:
Selling price = Cost ÷ (1 − Target margin)
To achieve a 50% gross margin with $25 in costs:
Selling price = $25 ÷ (1 − 0.50) = $25 ÷ 0.50 = $50
Many businesses target specific gross margin levels because investors and benchmarks are expressed in margin terms, making this framing more practical for planning.
Method 3: Value-Based Pricing
Value-based pricing sets price based on the value delivered to the customer, not on your costs. This is typically the most profitable approach when it can be applied, because the ceiling is the customer's willingness to pay rather than your cost structure.
To apply value-based pricing:
- Quantify the outcome your product delivers (time saved, revenue generated, cost reduced)
- Identify what alternatives the customer has, and what they cost
- Price below the full value delivered, but above alternatives, capturing a share of the value for yourself
A B2B software tool that saves a team 10 hours per week at a $50/hour labor cost saves $500/week, $26,000/year. A $5,000/year price tag captures less than 20% of that value while being hard to argue against on ROI grounds.
Value-based pricing is harder to apply to commodities or consumer products where switching costs are low and comparison is easy. It works best where outcomes are measurable and the customer's alternative is expensive.
Competitive Pricing
Most businesses benchmark against competitors as a sanity check. Pricing 10–20% above a direct competitor requires a clear reason (better quality, brand trust, better support). Pricing significantly below usually means accepting lower margins or signaling lower quality.
Use competitive pricing as a reference point, not the primary input. If your cost structure is different from competitors, pricing at the same level may mean very different margins.
Psychological Pricing
Certain price points are perceived differently than their numeric value suggests:
- Prices ending in 9 (e.g., $49, $199) feel lower than round numbers
- Round numbers ($50, $200) can feel more premium in some contexts
- Anchoring a higher price next to your target price makes the target feel reasonable
These effects are real but small. Get the strategy right first; psychological tactics are fine-tuning.
When to Raise Your Prices
Many businesses undercharge for years because raising prices feels risky. Signs you may be underpriced:
- You have more demand than you can handle
- Customers rarely ask about price before buying
- Refund or churn rates are low and customers express high satisfaction
- Your competitors charge more for a similar offering
A price increase of 10–20% that results in 10–15% volume loss often increases total profit significantly, because the remaining customers generate higher margin per unit.