Tip #4 Define Your Pricing
Pricing is usually a calculation based on the cost of your product or service, the expenses in your business and your future expected income. I say “future” because when you are starting out you will most likely not be able to draw an income from your company, but if you do not plan to draw an income right from the beginning you will not ever get one. So here is an overview of my process to determining the cost of a product or service so that you can plan for an income.
Everything you sell must cover the cost of everything it takes to run your business, so, to start you will need to know the cost to run your business. Here is a small list of things that you may need to include in this. Do not add in manufacturing costs, we will look at those in a minute.
- Lease, rent, or mortgage
- capital costs (for large equipment e.g. manufacturing tools, computer networks, office furniture)
- office supplies
- vehicle expenses (gas, repairs)
- employees, contractors, hired professionals (e.g. bookkeeping, accounting)
- phones, wireless, internet
- website and web hosting
- licenses, contracts, legal work
- marketing and advertising
Talk to your accountant for a full list. There may be things you did not include and you should so you can get the tax benefits.
If you have a product, pricing may be easier to define, but not always. There is a set cost to manufacture or purchase the product for sale. If you are the manufacturer and you do not know this cost then you have some work to do. You should know the cost per unit to manufacture (as you would if you were purchasing the product for resale). There are several costs that are associated with the product, such as:
- product development
- supply chain costs
- inventory management
- manufacturing costs
As you can see, you have a lot of work to do when considering the cost of your product.
Know your market
You cannot just do the calculation and arbitrarily set a price that gives you a 35% margin on your product. As much as you want to make that money quickly you may price yourself out of the market. Now you have to go back to who your target market and competitors are. What are they willing to pay, how are you positioning your product and what are your competitors charging.
If you are positioning your product as a high-end item, then know what the range of prices is for that product. You can choose to be right at the very top of the high-end, but you had better have a great position on why your product is worth that price.
How much can you sell
So now you know how much it will cost and what the price range is for your products in the market you wish to sell it in. To determine the exact price you need to take into account how much you have to sell and how much you can sell to be able to make a profit. If you top out in your manufacturing process at 100 units per day, but it takes sales of 1000 units per day to pay for your business and make a profit then you are:
- not charging enough
- not manufacturing enough
- not in business to make money
Make sure your price = profit + costs so you can continue to grow and succeed.
If you have a service you may have more room in your pricing model. It is more difficult for customers to shop around for some services and often service is based on expertise. If you are the expert with years of experience then you will demand a higher price. The calculation is the same for service as it is for product (price = profit + cost), but the profit margin can often be defined by you and what you think your market will tolerate, and not what your competitors are charging. This would not be true if you are competing on price, like many automobile service stations have to, but it is true for high-end service centers, like those niche experts that work only on a specific import.
Here are some things to look at in your service to determine if you are going to make money at it.
- Start by determining what your hour is worth. (even if you don’t plan on charging an hourly rate)
- Document your entire process so you know exactly what has to be done to fulfill your clients purchase.
- Determine how much preparation time is required
- Calculate how much you would have to get paid to get your hourly rate to handle the entire process
- Calculate how many purchases you would have to have to cover the cost of your business and make a profit
If you do not have enough hours to fulfill the number of purchase required to run the business then:
- you need more employees
- you need to leverage your time better
So Now What
So now that you know the cost of your product or service and what you are going to charge, how does this affect your business plan? Well, by defining all the costs involved in selling your product you just defined all aspects of the operation of your business. You know who is working for you, how you will manufacture a product, what hours are required to run you service successfully, etc.. The costs outline all aspects of your business, and knowing this will make writing your business plan much faster and easier.