How to price a product: cost-plus, keystone and value

To price a product, start from what your customers pay now for the alternatives they use, then check that price against your costs. Each sale has to cover the unit, the selling costs and the cost of winning the customer, and enough sales have to pay back your first order.

Cost-plus and keystone pricing both start from cost, which makes them useful as floors and as checks. Neither tells you whether a price leaves enough to pay for ads. It assumes a physical product made in a factory and sold online, with pre-orders taken before the first order is placed.

Cost-plus, keystone and value-based pricing compared

What is cost-plus pricing?

Cost-plus pricing sets the price by adding a fixed markup to what the product costs you:

Price = cost per unit × (1 + markup %)

A product that costs $26 with a 50% markup sells for $39. You can also start from the margin you want: price = cost ÷ (1 − margin %). A one-third margin gives the same answer, $26 ÷ (1 − 1/3) = $39. An open business textbook on LibreTexts calls it "perhaps the most widely used pricing method", and notes that it ignores how customers value the product.

For an online brand there is a second gap: the markup covers only the costs you put into the formula, and the cost of winning each customer is easy to leave out.

What is keystone pricing?

Keystone pricing is a retail rule of thumb: a store sells an item for twice what it paid the supplier.

Retail price = wholesale cost × 2

A store that pays you $34.50 sells at $69. That is a 100% markup on the store's cost, or a 50% margin on the price. Oregon State University's product development program describes it as the traditional baseline for retail prices. Keystone is the store's rule, so for a brand it works in reverse: if shops that use it will stock your product, your wholesale price is half your retail price. Some founders double their own landed cost instead, and step 3 shows what that leaves online.

How to price a product: a worked example

The numbers are invented and round. A founder is launching a waxed canvas log carrier with leather handles. She will sell it from her own US website at a price excluding sales tax. The factory's minimum order is 300 units at $9.00 each, and the landed cost of that order, with freight, duty and the other charges to her door, is $4,200, or $14 a unit.

Each sale also has selling costs: $10 for packaging and postage, a $2 allowance for returns, and the card fee. Stripe charges 2.9% of the price plus 30 cents for a payment with a US card. From a small ad test she estimates that winning a customer costs $25. If you haven't got these figures yet, a feasibility study covers how to find them.

1. Add up what one sale costs you

Start with everything that is spent each time one unit sells: the landed cost of the unit plus the selling costs. This is your floor. Below it, every sale loses money even before you pay for ads.

For the log carrier, that is $14 plus $12.30 plus 2.9% of the price. A founder pricing by cost-plus takes the $26.30 that doesn't change with the price, puts 50% on top and gets $39.45, which she would round to $39. Doubling the landed cost, keystone style, gives $28.

2. Price against the alternatives buyers use now

Value-based pricing sets your price from what buyers already pay to get the same job done, then moves it for what yours does better or worse.

Choose the alternatives. List everything buyers use for the job, including doing nothing; product differentiation covers building that list. Then mark the closest one: the option that does the same job and that buyers already pay for and trust. Buyers will hold your price against that one.

Find what each one really costs. Use the price on the seller's own site when nothing is on sale, add shipping if the buyer pays it, and divide pack prices down to one unit. Then ask a few owners what they paid. Where that differs from the listings, use the owners' figure, because it is the one buyers remember.

Decide where to sit. Start at the closest alternative's price. Move up only for a difference a buyer can check before paying, such as a feature in the photos or a longer guarantee. Move down for anything they can't yet judge, such as how long a new brand's product lasts.

For the log carrier, the list is:

• Carrying logs by the armful: free, with bark on your sweater and a trail across the floor.
• A nylon log tote: about $25, and it slumps when you put it down.
• A wicker basket: about $45, but you can't carry it from the woodpile.
• Waxed canvas carriers from established outdoor brands: about $85.

The $85 carriers are the closest. Hers matches them on everything a buyer can see in the photos, but the brand is new and nobody can yet say how well it lasts. She prices at $69, below the brands buyers trust and well above the tote that slumps. Once she has reviews and a guarantee to show, she can move toward $85.

The FTC's pricing guides limit how you show these prices on your page.

3. Work out what each price leaves after costs and ads

Run each candidate price through the same costs. What a sale leaves after the unit and selling costs pays for ads, and what is left after the $25 customer is profit.

Doubling the landed cost leaves $0.89, because the selling costs come to almost as much as the unit. At the cost-plus price each sale leaves $11.57, and once the $25 customer is paid for, each sale won through an ad loses $13.43.

4. Count the sales that pay back your first order

The first order is spent before anything sells, so check how many sales it takes to get it back. This is the method from what MOQ means for choosing an order size:

Sales to pay back = landed order cost ÷ (price − selling costs − cost to win a customer)

At $69, each sale brings in $29.70 toward the order, so it takes 142 sales, 47% of the 300 units. At $39 it would take 7,369, far more than the 300 she is making, so that price can't work with ads at $25 a customer.

Before settling on $69, she checks two more things:

• The ceiling on customer cost: at $69 she can spend up to $40.70 to win each customer. Above that, each sale doesn't cover its own unit.
• Whether a higher price pays back faster: at $79 the payback falls to 107 sales, but a higher price can turn fewer ad clicks into orders. If that pushes the cost of a customer to $35, the payback is 143 sales, slightly worse than $69 at $25.

She stays at $69 and plans to test $79 later, once real ad figures come in.

5. Check the wholesale price if shops might stock it

If you might sell through shops later, check now, because shops that use keystone pricing will sell at twice what they pay you. A shop selling the carrier at $69 pays her $34.50. After the $14 unit and an invented $2 a unit to ship a carton to the shop, she keeps $18.50. That sale needs no postage to the customer and no ad, so it leaves more than the $15.70 from an online sale won through an ad, although finding and supplying shops has costs of its own.

At $39 the shop would pay $19.50, leaving her $3.50 a unit, so a price set from cost can rule out shops altogether. Keep your own online price at the shops' price as well, or you undercut the shops you sell to.

6. Test the price with pre-orders

Every number above is an estimate until people pay, so take pre-orders at your chosen price before you place the order. They tell you whether people buy at $69 and what a customer really costs to win. Rework step 4 with that figure before you commit to the factory. It is the same test as checking demand before you build, with the price as part of what it checks.

Draper's Set Your Pricing workshop does this research for your own product, from competitor prices to how soon each customer pays for itself.

Handmade products, refills, shop-only brands and new categories

• If you make the product by hand, your time is a cost per unit. The craft pricing calculator adds it to materials and fees.
• If customers buy again, as with refills or consumables, a customer's first order doesn't have to cover their ad cost on its own. Count only the repeat orders you have evidence for.
• If you sell only through shops, keystone sets the retail price and there is no cost to win each shopper. Check that the wholesale price covers the landed cost and what it costs you to win and supply each shop.
• If the product is new to buyers and the nearest alternative is doing without, there is little to price against. Take pre-orders at two prices and see which one sells.

Related questions

Once the price works, how to take pre-orders covers running the test, and what landed cost includes breaks down the $14 line by line.