Success in business is all about knowing your value. For consumer packaged goods (CPG) suppliers, success is also about knowing the value their products add to the marketplace, so the products reflect optimal pricing.
Pricing is of vital importance to CPG suppliers because it directly affects their bottom line and competitive strategy. Yet, many CPG suppliers struggle with deciding which figures to put on their price tags to attract enough consumers willing to pay while protecting their profit margins and competitive positioning.
Particularly in the startup phase, business owners are overwhelmed by relentless pressure as they launch a new company, study their customers and constantly keep an eye on their competitors. When CPG companies expect to get their prices right from day one, it only adds to their stress.
To relieve CPG companies of the confusion and pressure to price their products appropriately, we’ll look at common pricing concepts and best practices.
For CPG success, know your numbers
First off, pricing isn’t a one-and-done event; it’s an ongoing process. It takes time to discover where the price is right. If CPG suppliers charge too much, consumers will walk away. If suppliers charge too little, they can’t cover their costs due to insufficient cash flow.
By contrast, effective pricing can help CPG suppliers maximize their sales and deliver sustainable profit margins, support consistent brand positioning and reflect what consumers are actually willing to pay.
In addition, knowing their numbers will help CPG suppliers understand what they can afford to charge and how flexible they can be to stay competitive. Knowing this price range can also help CPG suppliers compete effectively online, where product prices can fluctuate hourly.
How pricing affects the consumer experience
According to McKinsey, today’s consumers are price sensitive, which means pricing weighs heavily on their decision of whether to purchase a product. This consumer behavior is most prevalent among lower income households.
Among households that earn less than $50,000 per year:
- 46% are looking for ways to save money
- 37% for sales and promotions
- 36% pay more attention to prices
- 32% use coupons and loyalty cards more often
- 29% shop around to get the best deal1Grimmelt, Anne, Max Magni, and Alex Rodriguez. US consumers in 2019 are ready to spend—but wisely. McKinsey & Company. December 2019.
Yet the pricing spectrum ranges from value items with lower prices on one end to premium products with higher pricing on the other end. As we saw in Value Shopping Still Soars in a Strong Economy, consumers started to pay closer attention to price during the recession in 2009 and they still do so today. Conversely, we learned that affluent Americans seek premium products – and accept the higher price tags associated with superior quality. How CPG suppliers price their products relative to rivals’ reflects the value of their offerings and influences consumers’ expectations.2 Odjick, Desirae. How to Price Your Product: What You Need to Know About Pricing Before You Launch. Shopify. May 28, 2018.
Pricing best practices
These overarching principles can guide CPG suppliers’ pricing strategies:
- Skip the price war: Avoid competing on price alone, as it suggests the item is a commodity rather than a value-added offering that is worth more. CPG suppliers can invest in building their brand name and add exclusive products to their assortments to strengthen their resilience in the event of a price war.
- Know the audience: Research the desired consumer market to understand how the product serves their needs and what price range they are most willing to pay. Understanding price elasticity will help CPG suppliers know how responsive consumer demand is when the price changes.
- Analyze competitors: Look at the whole value of what rivals offer, including any value-added services. Monitor competitors’ past price levels to spot patterns and anticipate fluctuations in consumer demand.3 Zahorsky, Darrell. Pricing Strategies for Small Business. The Balance Small Business. February 12, 2020.
- Command a premium: Boston Consulting Group says that instead of passing inflation hikes along to consumers, top companies charge a premium to reflect the value of the innovations they make to their products and they can strategically increase their prices to boost volume growth.4 Edelstein, Peri, Krishnakumar (KK) S. Davey, Aman Gupta, Seth Marcus, Jim Brennan, and Cara Loeys. What the Fastest-Growing CPG Companies Do Differently. BCG. June 14, 2018.
Common pricing strategies
Here are several examples of pricing strategies to help CPG suppliers determine the price of a product:
- Cost-based pricing: Calculate the unit cost of a product then add a markup. (See the example below.)
- Competitive pricing: Set a price based on how competitors price their products.
- Value-based pricing: The supplier sets the price within a range determined by what consumers are willing to pay. This is also known as demand-based pricing.
- Price skimming: Initially set a high price, then lower it as competitors enter the market
- Penetration pricing: Initially set a low price to spark volume sales and word-of-mouth in a competitive market, then raise the price later.5Zahorsky, Darrell. Pricing Strategies for Small Business. The Balance Small Business. February 12, 2020 6 Carlson, Rosemary. What Is Pricing and What Are Some Common Pricing Strategies?. May 2, 2019.
The ‘best’ pricing strategy depends on a company’s objectives, needs and competitive leverage.
Example: Cost-based pricing
The following company pricing strategy example shows a simple way to determine the price of a product to cover business expenses and earn a profit.
1. Calculate the variable costs per product
Add up the cost of all the raw materials used to create one product unit. The amount that each unit costs is called the cost of goods sold. Additional variable costs include production costs, packaging, marketing shipping and owner’s labor costs. Let’s say the variable costs per product is $16.
2. Add a profit margin
When determining a profit margin, consider existing price points within the market. If a CPG supplier charges twice as much as its closest rival, the company may lose sales to a more affordable rival. Also consider that suppliers still need to cover their fixed costs. For this example, let’s say a CPG supplier wants a profit margin of 20%.
To calculate a target price, start with the variable cost and divide it by one minus the desired profit margin. For a 20% profit margin, the target price is calculated as $16 divided by 1 – 0.2, which is 16 divided by 0.8, which is 20. That means the target price is $20.
3. Add fixed costs
Fixed costs are the expenses CPG suppliers need to pay whether they sell one product or 1000 products. Common types of fixed costs are rent, taxes, insurance and utilities. CPG companies need to ensure they can cover these costs by performing a breakeven analysis to know how many units they need to sell to avoid eroding their profit margin.7 Odjick, Desirae. How to Price Your Product: What You Need to Know About Pricing Before You Launch. Shopify. May 28, 2018.
Regardless of the pricing strategy CPG suppliers use, knowing these numbers can also help them see how much pricing flexibility they have, especially when they want to put a product on sale. For instance, discount sales often represent a form of demand-based pricing, where decreasing demand prompts suppliers to lower their prices lower to clear the inventory.8 Carlson, Rosemary. What Is Pricing and What Are Some Common Pricing Strategies? May 2, 2019.
Getting the right price takes time
To reduce the stress of trying to pinpoint the perfect price for their products, CPG suppliers can use these pricing best practices. Since pricing is an ongoing process, CPG suppliers should continuously test and adjust their price points to determine the best pricing strategy for their needs.