Basically, your prices should cover your costs and provide a profit. This sounds easy, but unfortunately, there is no hard and fast rule for determining the price of goods or services. Pricing considerations include:
- Your costs of doing business
- The profit goal you want to reach
- The image of your business
- What your customers are willing to pay
- What the competition is charging
- Your judgment, based on research, of what the market can bear
The first task is to figure out how much money you need to break even. This is known as a “break-even analysis” and is an important financial tool. Be sure to include ALL your costs, including cost of goods (materials plus labor), selling costs (variable costs such as advertising, delivery, commissions, supplies, etc.), overhead (fixed office and administrative costs), interest on loans, taxes, etc.
Group the costs into two categories: variable costs and fixed costs. Variable costs change as your sales go up or down, while fixed costs (such as rent, insurance, etc.) remain the same no matter how much you sell. You can figure out the break-even point with the following equation:
Break-even point = fixed costs ÷ gross profit
(Fixed costs = sales – variable costs)
(Sales = projected sales for the period of time)
(Variable costs = sum of all the variable costs/period)
With this formula, you can determine the level of sales necessary for profit, the results of raising or lowering prices, and the results of increased or decreased sales. Use the break-even analysis to make decisions about your business.
While there is no magic number, there are several pricing strategies that may help in coming up with a reasonable price.
- Suggested going rate. The manufacturer will often suggest a retail price for products.
- Full-cost pricing. Most often used in manufacturing or retail businesses, this strategy calculates the total cost of the product and adds a percentage for profit. The most difficult part is to calculate total cost.
- Gross profit. This is only at the cost per unit of product rather than at the total costs of doing business. Price is calculated by adding a percentage to that direct cost. This percentage can be a mark-up based on knowledge of the market and other costs of being in business, or it can be a mark-on, which is based on an industry standard. Either way, makes sure the prices cover all your costs of being in business.
- Competitive pricing. This method looks at what the competition is charging and charges accordingly.