Put a price on a product

Regardless of the type of product you are going to sell, the price you charge your customers will have a direct effect on the success of your business. Although pricing strategies can be complex, the basic rules are straightforward.

All prices must cover costs and profits.
The most effective way to lower prices is to lower costs.
Prices should be reviewed frequently to ensure they reflect cost dynamics, market demand, response to competition, and profit objectives.
Prices must be established to ensure sales.

Before you price your product, you need to know the costs of your business. If the price of your product or service does not cover these costs, your cash flow will be cumulatively negative, your financial resources will be exhausted, and your business will eventually fail.

To determine how much it costs to run your business, include rent on property and/or equipment, loan payments, inventory, profits, financing costs, and salaries, wages or commissions. Don't forget to add the costs of markdowns, shortages, damaged merchandise, cost of goods sold, and desired profit to the list of operating expenses. Treat profit as a fixed cost, like a loan or payroll payment, since no one is in a business to make ends meet.

Because pricing decisions require time and market research, the strategy for many owners is to set prices once and hope for the best. However, such a policy risks profits that are elusive or not as high as they could be.

When should you review prices?

When you introduce a new product or a new product line.
When your costs change.
When you decide to enter a new market.
When your competitors change their prices.
When the economy experiences inflation or recession.
When your sales strategies change.
When your customers are making more money because of your product or service.

The most important thing to add into your cost calculations is profit.

Price based on a plus in cost

Many manufacturers set the price based on a plus in cost. The key to being successful with this method is to ensure that the amount considered the plus not only covers all general expenses but also generates the percentage of profit that you require. If your overhead amount is not accurate, you risk profits that are too low.

The following calculation is an example that helps understand the concept of pricing based on a cost plus:

Materials cost: $30
Labor cost: $50
General costs: $40
Total cost: 120$
Desired profit (20% sales): $30
Required selling price: $150

Ask price

Demand-based pricing is determined by the optimal combination of volume and profit. Products that are generally sold through different sources at different prices, retail, discount chains, wholesalers, or direct mail, are examples of goods whose price is determined by demand.

A wholesaler may purchase larger quantities than a retail customer, resulting in purchasing at a lower price per unit. The wholesaler benefits from a greater sales volume of a product at a lower price than that of the retailer. A retail customer generally pays more per unit since they cannot buy, store and sell a large quantity of product like a wholesaler can. It is for this reason that retail clients charge their customers more.

Demand pricing is difficult to master since you must correctly calculate in advance what price will generate the optimal price-volume ratio. In pest control, volume pricing is optimized with the example of buildings: Serving a single department is much more expensive and less profitable than serving the building.

Competitive price

Competitive pricing is generally used when there is a set price in the market for a particular product or service. If all your competitors are charging $100 to replace a windshield, for example, then that's what you should charge. Competitive pricing is most often used within markets with consumer items, those that are difficult to differentiate from one another.

If there is a major player in the market, generally known as the market leader, that company is the one that will often set the price that other smaller companies within the same market will be forced to follow.

To use competitive pricing effectively, know the prices each competitor has set. Then find out your optimal price and decide, based on your comparison, whether you can defend the prices you have set. If you want to charge more than your competitors, be prepared to defend a new price, such as providing superior customer service, or a better warranty policy. Before making the final commitment on your prices, make sure you have a clear and detailed understanding of the price level in the market.

If you use competitive pricing to set fees for a service business, be aware that unlike a situation where several companies are selling essentially the same products, services vary considerably from firm to firm. As a result, you can charge a higher fee for superior service and still be considered competitive within your market.

Trade margin price

Used by manufacturers, wholesalers and retail customers, a markup is calculated by adding a fixed amount to the cost of a product, resulting in the price charged to the customer. For example, if the cost of the product is $100 and its selling price is $140, the markup would be $40. To find the markup percentage, divide the dollar amount of the markup by the dollar amount of the product cost. 40 ÷ 100 = 40%.

This pricing method often causes confusion, not to mention lost profits, among many small business owners who are doing it for the first time, because markup, expressed as a percentage of cost, is often confused with gross margin, expressed as a percentage of sales price.