Know the cost of producing and bringing the product or service to market, then add a reasonable profit margin to determine the product’s selling price.
Product pricing is one of the most important decisions a business owner must make. Everything about your business, from cash flow, expense management, growth, and profit margin, hangs on it.
Every entrepreneur goes into business to sell their products and services and make a profit. Goods and services need money to produce, market, and sell, but product pricing determines whether you will continue in business or close shop. If you quote your prices below the production cost, you will likely make losses and fail. On the other hand, if your prices are too high in a competitive market, you may not sell enough products to cover operation costs.
Studies show that even small price variations can affect profitability by 20 to 50% margins. Business owners should evaluate price sensitivity when determining prices.
Establishing a pricing strategy can be daunting when you are new to pricing or launching a new business. The ideal way to go about it is to launch your products and test them with customers in the real market. But how do you set a launch price that works?
How do I price my products?
Many articles and blog posts online provide endless suggestions on pricing your product. Sometimes the information available can confuse new business owners. Fortunately, we provide you with a simple way to allow you to price and profitably sell your products.
If you want a workable retail price, there is a quick and straightforward way to price your product that you can start with. However, you do not have to use this price forever.
Accountants will tell you that profit is gotten by subtracting the product’s cost price from its selling price. Therefore, the straightforward way to quote your pricing is by adding the cost involved in bringing the product to the market and adding your profit margin.
This cost-plus pricing model looks simple, but it helps you sustain your business. Nevertheless, more is involved in pricing your products than simply adding a profit margin to the cost of the good.
Factors to consider in pricing
Product pricing is subjective and objective, depending on your business. Here are some factors that experts think are necessary for determining your pricing strategy:
- Cost-plus pricing– We have briefly touched on this strategy that involves calculating the cost needed to bring the product to the consumers (production plus promotional cost) and adding your expected profit margin. You will need to establish fixed, direct, and indirect costs to know the product’s overall costs. Ensure all costs are covered; otherwise, you will make a loss or sell at break-even.
- Competitors’ pricing– You also want to know what your competitors charge in the marketplace. You can know your competitors’ prices by looking at their websites, inquiring through phone calls, or talking to associates who have bought or used your competitor’s products. However, avoid the trap of price competition; instead, focus on differentiating your service, ambiance, or other ways that make you stand out. Your goal is to acquire loyal customers, not price-oriented customers.
- Perceived value to your customer– This is a subjective factor in determining your service or product pricing. Some entrepreneurs use keystone pricing by doubling the wholesale cost to account for profit. You may charge based on the perceived value and your expertise rather than the time spent providing the service for services.
Determining your costs
You cannot set prices without understanding the costs involved in providing the service or producing the product. Costs entail the following parts:
- Material costs– Material costs are costs needed to produce the product, such as the cost of raw materials and ingredients used in manufacturing the product. If it is a service, material costs are the costs of goods used in delivering the services. For instance, a cleaning service may need cleaning solutions, paper towels, rubber gloves, etc.
- Labor cost– This is the money you pay for direct and indirect labor you hire to help you produce the product or deliver the service. You will factor their salaries, wages, and benefits into the product. Salaries and wages can be based on the amount of work done or hours spent offering the service.
- Overhead costs– Overhead costs are the indirect costs used in providing a service or producing a product. Examples include wages and salaries for those who run the firm, like human resource personnel and administrative assistants.
They could also include taxes, rent, depreciation, advertising, insurance utilities, mileage, office supplies, etc. Remember, overhead costs may vary from year to year; you should not use last year’s figures for this year.
Establish a fair profit margin
After determining your product’s costs, you should mark up your products to attain profit for your business. Here is where pricing becomes an art and a science. The balance is achieving a reasonable profit margin while not developing a reputation for a business that overprices its goods and services. You can examine annual statements for small or mid-sized businesses to evaluate if your profit margin is reasonable.
Understand different service pricing models
Suppose you know the costs of providing a service or product, your competitors’ pricing strategy, and your customers’ perceived value. In that case, you should now figure out whether to charge a per-project rate, hourly rate, or request a retainer if you offer services. The industry may dictate your service pricing model, with some lawyers charging an hourly rate or retain and contrition charging per project. Pricing models include:
- Charging an hourly rate
- Charging a flat fee
- Variable pricing
Do not forget to include fixed costs.
Fixed costs are sometimes forgotten, but they also affect your profit margin and should be incorporated during product pricing. Fixed costs are always constant regardless of the number of products you sell and should be covered by sales revenue.
If you use a per-unit price, it can be challenging to factor in fixed costs. You can take variable costs data and set them in a break-even calculator spreadsheet and edit them appropriately. This tool will help you know how many product units you need to produce to sell at a break-even price. This way, you can make informed decisions about your pricing strategy.
The bottom line
As a business owner, you are responsible for propelling your startup to greater heights, and product pricing is part of the process. Several factors and strategies are involved in determining product prices. You can decide to go with the simple cost-plus pricing strategy or use the variable cost method. Regardless of the product pricing strategy, you want to balance making a sizeable profit and charging reasonable prices.Which product pricing model is working for your establishment?