Figuring out pricing

Many start-ups wrongly copy the hitchhiker when it comes to pricing. An outstretched thumb works by the road, but a finger in the air almost always plucks financially flawed figures.

Pricing products or services (especially the first time) isn’t easy, but considered calculation based on some key principles can make all the difference between business success and failure.

Using the following fictitious example throughout, this article seeks to highlight what needs to be done to price goods effectively.

Kay has started a business making specialist waistcoats and wants to sell them online. She is not confident about setting a price for the garments and is worried about being too expensive or too cheap. How does she price the waistcoats?

Know your ‘costs of sale’

It’s vital Kay knows what it costs her to make the waistcoats. Known as ‘costs of sale’ this information makes business and sales planning as well as pricing decisions much easier. After a bit of calculation she works out that the materials to make each garment cost £15 and it takes her less than half a day to make a waistcoat from scratch.

Kay is surprised at the inexpensive costs and thinks that by setting a price of £30 per garment she will be making £15 profit per garment – a 100% margin! But then she realises that the £15 profit in half a day has to also cover her own salary; and then there’s all the other bills such as energy, website costs, phone bills and bank charges etc. Before she does anything else Kay decides to work out her total costs each month.

Know your overheads

Kay discovers that including her salary, phone bill, energy costs etc. (but excluding all material costs to make the garments) she is committed to spending £2,000 per month on her business (these are her overheads). She reasons that she works 20 days a month which means each day costs £100 before she makes anything! Armed with this information, Kay is a little more confident about setting an appropriate price to make a profit. She scribbles the following information down on a piece of paper:

Waistcoats made in a day = 2  / Total Sales Value = (Price * 2) ?

Total Cost of Sale = £30 / Total Overheads = £100  (Total costs per day = £130)

Breakeven Point

Kay immediately sees that if she sets a price of £65 per waistcoat and makes and sells 2 a day she will breakeven! Then she realises she could set a higher price and make more money. But will anyone buy waistcoats priced at £65?

Competitor Research

Information, Kay tells herself, brings power and she immediately searches online to see how comparable waistcoats are being priced. She discovers that garments are available from £50 upwards and those of similar quality are typically around and above the £75 mark.

Kay concludes that if she prices her waistcoats at £70, they will be affordable to the customer, competitively priced and will ensure she is selling at a profit. The information gleaned from the competitor review has also helped her to promote the waistcoats so that prospects feel (rightly) that they are paying a very reasonable price for a first class high quality garment.

Most importantly, Kay feels she has a robust formula for working out future prices which means she can much more strategic in her thinking and thus construct meaningful forecasts and plans. In addition, she is more confident and informed about her wider business finances and now understands the fundamental relationship between costs, prices and sales figures.

You can read more about this subject on a number of good websites. The ‘Inc’ site is particularly useful and provides relevant pricing tips and advice. Likewise, if you are running a creative business, this financial information should prove very helpful.

Key Learning Points: To price effectively you must first work out your total cost of sales and overheads. Once you know your breakeven point and have researched competitors, you will make informed & confident decisions about pricing strategy.