on December 9, 2021 (last modified on December 6, 2021) • 21 minute read
Your pricing strategy can literally make or break your business. There are two numbers that every business owner needs to know when it comes to pricing: markup and margin.That’s because if you want to run a viable business, you can’t sell products at the same price you bought it at. You need to factor in a product markup (i.e. the difference between what you bought the product for and what you are selling it for) as well as your gross margin (i.e the difference between what you sold the product for compared to your costs of goods sold (COGS)).
In this post, we’re sharing what markups are along with how to determine the appropriate markup percentage based on the type of business you are running.
Markup is the difference between your product’s sale price and unit costs. So, the higher your markup is, the more likely your business will make money. Your markup percentage is simply markup x 100.
It is worth noting that markup and gross margin aren’t one and the same though. While markup looks at the difference between the sales and unit price, gross margin focuses on the difference between the sales price and cost of goods sold (COGS).
The biggest reason why determining markup is important is that it helps you run a sustainable business.
If you are selling products at or below your unit economics, you are on a fast track for bankruptcy (assuming you don’t have investors!).
So, your markup, alongside your gross margin, is a key factor in your business’s pricing strategy.
According to the 53 businesses we surveyed, 39.1% of them use gross margin to decide on pricing. This is compared to 34.8% that rely on markup.
For added context, all of the businesses we surveyed were small businesses. This is the breakdown based on the business type.
Here is a simple formula for calculating markup percentage.
(Sales Price – Unit Price / Unit Price) x 100 = your markup percentage
Let’s say you run an ecommerce shop selling catnip bubbles. (Yes, this actually exists!). You sell it on your website for $10. The actual unit costs for your business is $5. This means your markup is $5. And, your markup percentage is sale price – unit price/unit price x 100. So, your markup percentage for your catnip bubble product is 100%.
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Deciding what’s the appropriate markup percentage largely depends on the type of business you run, your margins, and your clientele.
For consultants and client service providers, here are some key factors to consider when setting your markup percentage.
A lot of professional service business owners started their companies because they have a specific skill set or worked in the particular industry as an employee first. Therefore, they can fast-track some of the pricing learnings by leaning on their past experiences.
For example, Devon Fata of Pixoul says, “I had the advantage of years of experience working for a company in my industry and developing a strong professional network before I launched my own firm. While I didn’t have direct experience selling or negotiating prices, I knew not only what a reasonable rate to charge clients would be, but also the cost of the talent I would need to hire. If you’re brave enough to dive into an industry you don’t already have experience in, my advice is to do your research. Reach out to your industry peers not only as a customer but also, if possible, as a colleague.”
Lattice Hudson adds, “After some trial and error with setting prices for my own services, I have narrowed down the process to some core concepts. Consider your target audience and keep your brand’s image at the focal point when setting a price. The identity of your business will be correlated with how financially accessible your product or service is to the public. Begin with some soul searching and know what you want to achieve in the near future with your operations before advancing with a particular strategy.”
You don’t necessarily need to stack the deck in your favor (with past experiences!) to determine your markup percentage. The most important factor to get rid of is knowing how to communicate your USP.
“A strong USP right from the beginning of TryHackMe was accessibility,” explains Emma Sivess. “The cyber security training market was notoriously expensive and often lacked creativity. There is really no limit to selling training plans so long as you have the capacity, so we wanted to take this and work on making fun, engaging learning pathways for a good price. On this, we operate on a subscription basis, costing $10 a month. This allows full access to our services. From as early as our launch, we knew as long as we could generate enough interest and users, this low price could work. Thankfully the need for our company was indeed high, and we have seen some brilliant quick growth – now growing at 10% every month. This also allows us to offer free courses and events (such as our Christmas Advent of Cyber.) In turn, this attracts more people to sign up to us and is a fantastic marketing tool.”
Pricing and positioning (USP and UVP) go hand in hand for all client service businesses.
Luisa Zhou explains, “When I started my business, I used a model called penetration pricing for services, so you penetrate the market by offering your services at the lowest fee that you’re comfortable working for. This is also the model I typically recommend for new entrepreneurs.
For example, if you sell coaching or consulting, that could be $1,500 for a 3-month package. If you sell done-for-you services, the price depends on the services you offer. You can calculate what you’re being paid at your job right now (if you’re an employee and if you are working in the same industry as your future business). That could be your hourly rate for the first few clients. Once you have some experience coaching, consulting, or offering done-for-you services, you can raise your rates and keep raising them as you gain experience, results, and testimonials.”
Another important consideration is the market you are in and how much competition you have.
“There are a number of things we considered when coming up with pricing,” says Sasha Matviienko of Citadel. “We analyzed competitor prices and considered our aggressive growth goals. So our approach has been to go for a lower price in order to grow the customer base. We know that psychological services in our industry are considered overpriced, that’s why our approach worked.”
Marc Bromhall of Trailer Hire Hub adds, “We look at the size of the addressable market, what the existing competitors are charging, and what we believe is the maximum price a customer is willing to pay for a service of our quality.”
Your pricing will also dictate your sales and marketing strategy, and even how prospects and clients perceive you.
“Pricing is more than just math since it depends on marketing strategies,” says Natalia Brzezińska of PhotoAiD. “A product’s affordability to consumers is not the only aspect to consider. Clients are likely to pay more for a unique product, a service offered by a company with similar values, or a last-minute discount. Well, as part of a company’s pricing strategy, those factors must be considered. Thus, we determine the base price and then adjust it to suit our marketing strategy.
Our pricing strategy is based on the keystone pricing strategy, which tells you to double the wholesale cost. Then we calculate the retail price with 50% markup for our basement price. Next, we compare it to our competitors’ prices. Finally, we select the pricing strategy we want to use, such as competitive pricing or price skimming, we consider psychological factors, and we establish a price that fits the long-term goals of our marketing campaign.”
Of course, you need to make sure that your price markup gives you enough margin to actually do the work profitably.
For example, Tucker Anderson of Black Diamond Junk Removal, says, “I set prices for my small business by looking at the typical cost breakdown for the junk removal industry. In our industry disposal costs are about 8% of revenue and labor costs are about 22% of revenue. The net profit margin for a junk removal company can range from 5% to about 30%. The reason for this variation is that new businesses need to spend more on marketing.
While a new business can spend 30% of revenue on marketing, an established business might only spend 10% of revenue on marketing.
Next, I also called our competitors. I priced my service to be less than the large, national junk removal franchises, but more expensive than other locally-owned, independent competitors. We price based on volume and how much space items take in our dump truck.”
While marketing agencies are technically professional services too, there are some special considerations you need to consider for your agency pricing model and how you set markup percentages.
The first factor to consider is if you are a general marketing agency or you operate in a specific niche. Your niche (or lack of one!) will dictate what you can charge.
“For our market, there’s a lot of competition and comparison shopping, so we have to be somewhat within line of the market standard,” says Nick Leffler of Loclweb. ”Though we’ve added a lot of value to our monthly subscription plans that let us charge more than standard hosting while still keeping the prices within reason for small business budgets.”
Patrick Garde of ExaWeb Corporation agrees, “We price our services based on the industry average. This way, we can justify to potential clients that our pricing is not high or low, and just within the average price range. We only offer discounts when clients require two or more services. We bundle our prices if that’s the case.”
Ethan Benge of Social Benge took a slightly different approach.
“I run a small digital marketing company that works specifically with small businesses,” says Benge. “The first step in deciding our pricing was to dive deep into our audience and find out who they were. Most of our clients (small businesses) are struggling, just starting out, and have low budgets. It was our goal to be able to provide website design and SEO services that are actually affordable for this demographic. We spoke with and discussed the different budgets and pricing that small business owners in all different niches can and would pay for such services. After that, we compared with all of our direct competitors.”
Just like professional service businesses, marketing agencies need to weigh how their pricing strategy will affect their markup(s).
For example, Jacob Landis-Eigsti of Jacob LE says, “Our agency does results-based pricing, so it’s very important that there is the potential for our business and the client’s business to be very profitable if our ad campaigns do well. We typically look at their current results and put together a plan to improve their performance by 20-50%. Then, we get paid a percentage of the additional profit we generate. This requires being very selective with who we work with and takes on some risk, but leads to more profits when campaigns are incredibly profitable.”
Other agencies rely on value-based pricing.
“I work out on the percentage that needs to be covered by services of fixed overheads,” explains Philip Pasma of Asterisk Marketing Inc. “We simply sum up all these costs and divide them by the volume to find a break-even figure. It requires my business to set up a mark-up point as well to express as a percentage of break-even.
However, the industry knowledge guides better in setting up the mark-up. We do not use cost-plus pricing but consider the combination of cost-plus and value-based pricing. The value-based pricing approach concentrates more on the readiness of customers to pay for a service. It is more like how much value the products are generating among people. It requires considering the market competition and factors such as the brand image at the same time. By following both approaches, we have placed a 55% mark-up for highly valued products and 25% for other products.”
One way to increase your markup percentage is to do a better job communicating your UVP with prospects and clients.
“When setting the prices for our SEO services, our main consideration was really where the service gap was for our customers,” says Dan Rawley of Honeycomb Search. “Most of our clients are small businesses and start-ups who are normally priced out of accessing traditional SEO agencies, so we wanted to pitch our prices at a level that made high-quality SEO services accessible to them.
In that way, market research was really important to our price-setting process, but equally, we knew the value of our services and that setting our prices too low may give the impression that we would be cutting corners. That goes against our whole ethos – so aligning prices with our brand values was important too.”
For ecommerce businesses, the three biggest considerations for determining product markup is market research, pricing, and positioning.
The vast majority of ecommerce businesses are selling commodity products, which means the pricing windows for what you can get away with charging are constrained. A commodity product, like potato chips, will not be able to have 500% markup prices (at least most won’t) like some SaaS and service businesses.
This also means market research is even more important.
“For our individual products, we looked at competitors’ prices, our costs, and what we felt was acceptable from a margin perspective,” says Alex Willen of Cooper’s Treats. “That gave us a range, and we erred towards the high end. We decided to aim high because it’s easier to reduce the price later than to increase it, our products use much higher quality ingredients than our competitors, and that gave us room to discount bundles, which are our main sellers.”
Joel Phillips of Home Guide Corner adds, “As a small business owner, I have to thoroughly research the market before deciding on the price of my products or services; some of these factors include:
I cannot give much leverage to customers because my business is small in stature and mainly because of the volatile market due to Covid. The prices we set are primarily an accumulation of all the factors mentioned above, and it has helped us derive profits in tough times. Sticking to these principles makes it easier for our marketing department to value our products through a defined system.”
After you have done some market research, you can set your price based on what you think customers will pay.
“The primary consideration was the number of items the consumer is willing to buy,” says Rick Hoskins of Filter King. “Most people need more than one filter for their home’s HVAC system. Some with bigger houses need more. We decided to offer a discounted price for bulk purchases because our primary focus is on retaining customers.”
Or, another approach to pricing is to run experiments.
“I ran paid media tests to establish digital CAC using preliminary industry pricing,” says Alex Dask of Beam. “I then incorporated COGS and other expenses to identify a final CAC. While we are a new brand I focussed on setting pricing to simply achieve a break-even return. This allowed us to set pricing as competitively as possible while still ensuring we are able to scale our paid media campaigns.
As a new brand, it was also important that we were cheaper than more established competitors and the above pricing met this requirement as well. As we grow the brand the plan is to lift pricing over time so that we move from a break-even customer acquisition model to generating profit that can ultimately fuel our growth.”
Another factor to consider is how you position your products.
For example, Eric Mills of Pro Support Accessories says, “My business sells eSports accessories, and we are primarily focused on our main product: support sleeves for professional tabletop players. We went for economy pricing because we are still in the process of building up our brand and reaching out to our audience, so our products go for $15 a piece. As our business continues to grow, we will look to implement premium versions of our accessories, but for now, we focus on growth.”
The biggest considerations that SaaS companies need to consider are their pricing and the market they are in.
Your pricing strategy affects every aspect of your SaaS business from sales and marketing to support, product, and engineering.
“Pricing is a delicate balance,” says Cody Miles of Ashore. “You have to set the price high enough to make a profit, but if you go too high, it will be challenging to bring in customers (especially when you’re first starting out). We’ve found that the best way to find that middle ground is to consider your competition. In a competitive industry such as our own, people tend to go with the company that brings the most value for their dollar.
As a bootstrapped startup, we were able to run leaner than our investment-backed competition. We started with an MVP, ensuring that our cost was half that of our competitors when we first launched. As we expanded our product and grew our client base, we were able to experiment with pricing, and we continue to do that today. Our software still costs less than our competitors, but it can compete feature for feature. So, we can position Ashore as both a price advantaged and a feature advantaged option.”
Alina Clark of Cocodoc says, “The competitor pricing and the economy were the biggest factors determining the price of our Saas product. In an extremely competitive field, pricing above your competitors, when you offer the same value places you at a disadvantage.
Customers will often compare prices and value, and choose the best value per price. As a business, our main concern was how we would get a market share, without going so low that the products would be unprofitable.
Setting the prices just around the same place as the competitors worked in that regard. Undercutting your competition by underpricing can have a disastrous effect on your bottom line as a business.
On the other hand, overpricing can inhibit the growth of your business. It often feels like customers will go for the cheapest product in the market, but that’s not the case. Customers go where they feel like they’re getting their money’s worth. As such, a high price should be commensurate with the value offered by your product.”
Felix Tang of Business Trade agrees, “The factors that we considered when pricing our products came down to several key factors such as pricing from the competition, size of the intended customer based on volume and having an enticing offer for new signups.
Obviously, pricing ourselves too cheap would not be good long term and would be detrimental to our business, whilst pricing too high would limit the potential reach of our product as we are relatively new in the market.
The process included conducting market research on our competitors, creating our own product segments based on what we felt would work in the market based on our value proposition. We ultimately settled with four different prices and an additional add-on service for automated feeds.”
However, if you want to optimize for market share, it can sometimes be advantageous to price your product cheaper than the competition or offer a freemium tier.
“If you’re selling a SaaS, a freemium pricing strategy can help you build your customer base and sales momentum quickly,” explains James Diel of Textel. “By offering a basic package or free trial to a user, you can give them enough experience with your product to upgrade to a higher price point. Set your premium price point to stay competitive within your market – this requires some in-depth competition analysis to find your magic number.”
The opposite holds true if, for example, you are a lifestyle SaaS business where you want a lean team with higher profit margins. Then, positioning your business to go after the premium market can make sense.
“We are a small software company developing a single product,” says Petko Georgiev of Milenix Software Ltd. “That’s why we decided early on that we will position our product as the premium note-taking/personal information manager software for Windows on the market. That made decisions on our pricing strategy comparatively easy. We’ve set our price as the highest among our competitors. So, we sell fewer units to fewer people, but we can devote more attention to each customer that way.”
Notice a trend yet? Regardless of what business you are in, your pricing strategy and markup percentage are directly related.
For many of the businesses we surveyed, they priced based on competition.
“We needed to know the needs of our market and research our competitors to help us determine our strategy,” says Ryan Rockefeller of Cleared. “The way we set our prices can affect how our customers perceive us. Our goal is to provide affordable products and services of high quality. However, a really low price might make them question quality. High prices conflict with our belief in affordable care to help those who desperately need medical care. Both quandaries could cause us to lose out on profit and hinder patient access to treatment.”
Braden Norwood of VTR Learning adds, “Pricing and customer psychology are very interestingly intertwined. When VTR Learning first started selling our online business courses, we attempted to take the “low-cost” approach. And we quickly discovered that this didn’t work. Essentially, we were undervaluing our product, and the market recognized it.
Since the prices were so low compared to our competitors, many individuals were actually wary of us, and some even thought we could be running a scam. So, we determined to raise our prices to meet industry standards, comparing against our competitors, accounting for the length of each course, and so on. Ultimately, we determined to raise our prices to sit comfortably in the middle of the range of competitor prices, so as not to undervalue our product while keeping it reasonably affordable. And when we did that, the suspicion fell away.
In fact, after raising our prices, we saw year-over-year sales increases by 62% and 26.3% respectively. So, in our case, setting low prices wasn’t the right move to make, since it increased buyer suspicion.”
In sum, determining your markup percentage is absolutely essential to running a sustainable business. However, how you go about this process will depend on the industry you are in and your business model.
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