When you are setting up a business for the first time, it can be quite difficult to know what price to set. You need to think about what your customers are willing to pay what the competition is charging and your costs.
As a rule of thumb, it is best to aim high as you can, as you should always lower your price rather than increase it. If your price is low, you may attract a lot of customers but you may lose them if you need to increase the price. You may also be losing money because your price does not cover your costs. Customers may think that if your product is cheap, it can't be good. Customers would be happy to pay for quality - value for money is often the best option.
When comparing your product to competitive products, you do not necessarily have to follow their pricing. Ask yourself if your product or service compares favourably and whether you can justify a higher price.
When considering your costs, it would be helpful if you did a forecast. This will allow you to be more informed and realistic about the price you charge. Bear in mind that you will need to charge a fair and competitive price with a reasonable profit. Your gross profit will need to cover all overheads and expenses. You take your money (your drawings) from what is left, that is your net profit.
Costing Formulae
There are three main costing formulae you can use to work out a cost for your service or cost for your product.
1 Daily/Hourly Rate
If you are providing a service, for example consultancy, you may find it useful to cost your service based on time calculation. You do this by first adding the number of days you will not be providing a service in the year. This will include weekends off, holidays, bank holidays, administration (about a day a week) and contingency days for any emergencies. Subtract this figure from the number of days in the year and this will give you your potential earning days. Then work out how many hours each day you will work and this will give you your total potential hours for the year.
To calculate your daily/hourly rate the formula is:
Business Overheads (fixed costs pa) + PSB (Personal Survival Budget - money taken out business to live on) divided by Number of days/hours available to sell = Cost per day/hour.
2 Cost of Product
The formula below applies if you are making something that you are going to sell.
Business Overheads + PSB divided by Production (the total number of items you produce) plus the Variable Cost per item (the variable costs per item will be know when you start making them) = Total Cost per item.
3 Mark up and margin
You business can only exist if you make a profit. The profit can either be as a percentage of the cost price or the selling price. If the profit is based on the cost price, it is known as Mark Up and can be expressed as follows:
Selling Price - Cost Price
--------------------------------------- x 100
Cost Price
If based on the selling price it is known as Margin and can be expressed as follow:
Selling Price - Cost Price
--------------------------------------- x 100
Selling Price
When pricing your product, make sure that the selling price provides an adequate margin to produce a profit.
There is no definitive method of setting a price. Your aim should be to set your prices initially at the level, which gives you your highest profits possible. Easier said than done!
Tips To Know When Setting Your Prices
Determining prices must be based on a broad, thoughtful basis. It requires a basic understanding of both your financial and business goals. Below are few principles to consider when you decide what prices to put on your product or service.
Keep your prices realistic. A realistic price is the price you set after taking into consideration various factors: the direction of your business, your cost structure and expenses, your resources and financial goals. Avoid setting your prices based on “what everybody is charging.” What is right for your competitors may not be profitable for your business. After all, their goals, strategies and financials may be different from yours. Research your competition and see what they are charging, but do not copy their pricing structure just to charge what everybody else is charging. Set your prices based on your own situation.
Cover all your costs. The price of your item should cover the costs associated with it, its contribution to the overhead, and profit. A successful pricing strategy is one that results in the most dollars after all your costs are met. Be careful in setting your prices too low: while it may attract a large sales volume, you may not be making enough revenue to cover the costs of selling the merchandise. If you set your prices too high, your sales volume may be so low you can't cover operating expenses.
Check your prices against inflation. Your prices must keep up with inflation. Inflation increases your cost of doing business, with the prices of your materials, overhead and other costs increasing. If you maintain your prices despite rising inflation, you will erode your profit margin. Allow your business to increase your prices at least once a year, but give your customers sufficient warning about the price increase. Once you’ve established your policies, constantly monitor your prices and operating costs to insure profit.
Include in your pricing the value of your time. Avoid committing the mistake of not including a salary for yourself, particularly if you are operating a service business. Your time is valuable, and you need to compute it in your pricing structure.
Customers are not always looking for the lowest price. Price is not always the topmost concern of customers. There are many customers who do not mind paying higher prices, particularly if they know that they are purchasing exclusive merchandise, or your business is located in a convenient or high-end location. Many customers are willing to pay premium prices for quality service: speedy delivery; helpful and friendly customer relations; excellent product knowledge, or satisfaction in handling complaints.
Price low, but smart. A common pricing strategy for small business. particularly new entrants into the market is to price low just to get the work. By pricing low, the aim is to penetrate the market and get as much repeat business.
However, be aware that pricing low can have adverse repercussions on your business. First, a low price may signal a low quality product and service. Be careful in setting prices too low. Second, it may be difficult to raise prices later on once customers are accustomed to your low prices. Third, your start-up business is yet to develop economies of scale that makes it hard to compete on price.
Use discounts with care. Offering discounts is a good strategy for encouraging repeat/bulk orders, bundling sales, and early payment of customers. Discounts also allow you to more quickly sell products with vanishing opportunity -- e.g. products with sell-by dates, seasonal and quick obsolescence like fashion and technology. You can also stimulate demand for your products during the times when your product/service is less popular. Discounts are also used to clear out merchandise that has become outdated.
