Last Updated: Apr 19, 2017
How do you figure out what to charge? How much is too much and how much is too little? Setting prices for your products is one of the most important business decisions you’ll make. Here’s what you need to keep in mind when deciding what to charge.
It seems so easy, right? You charge enough to make money, but it’s far more complicated than that. What you charge determines the future of your business. You can charge too much and you can charge too little. Each leads to the same result: failure of the product and/or failure of your business. Here’s what you need to consider before putting your product up for sale.
Every successful business owner first knows their numbers. If you designed and manufactured the product, you know every piece and part. You know the price of each component including all associated costs like shipping and labor. You carefully considered the best way to manufacture a quality component in the most cost effective way.
In other words, you have the cost of the item detailed to shocking proportions.
If you’re reselling the product, your numbers are less complicated but equally important. You know the product and shipping cost and you shopped every vendor you could find to get the best deal. You formed relationships that led to terms that keep the costs as low as possible.
Along with the direct costs, you know your indirect costs. Overhead costs like labor, utilities, insurance, licensing, and taxes get calculated on a per product basis. The direct cost plus the indirect costs are what you consider “cost.” Your cost includes everything.
You’re probably like most small business owners—you could get a little more detailed with your costs. If you know all of this information, congratulations. If not, do some digging and recalculating before you attempt to answer the question of what to charge. For the purposes of pricing, we’ll not take into account indirect costs since businesses vary widely, but you’ll have to add those costs before landing on a price.
You know that the margin is the difference between your cost (not including operating expenses) and your sale price. If your cost is $10 and you sell it for $20, your margin is 100 percent, but what is considered a good margin?
First, understand gross versus net profit margins. Gross margins don’t take into account operating costs. 100 percent gross margin is considered fantastic in most businesses. Grocery stores, for example, operate around 26 percent gross margin.
Auto dealerships, however, operate between one and two percent on average. For higher priced products, normal (not filthy rich) consumers can’t afford to pay a 50 or more percent markup, but a one percent margin could mean $500 or more in profit. The lower cost your product, the higher your margin, in general.
It’s Not All About Price
If it were only about costs and margins, pricing would be easy but here’s where it gets complicated.
How new is your product or business? If nobody knows you exist, you have to do something to get potential customers to your doors or website. Sometimes offering your product at a bargain price is a great way to build a customer base. This is why tech companies sometimes offer free versions of their products.
What’s the nature of your business? If you’re a discount store, you’re business revolves around price. If you’re selling Rolex wristwatches, most of your customers don’t see price as their primary concern. (If you have to ask, you probably can’t afford it, right?) Your type of business has some determining factor in your pricing strategy.
Are you going to be the business that charges less to sell more or charge more and sell less? Each strategy can work, but you have to find the sweet spot. Do this with a little market research. Put together a survey along with some product samples. Let 20 or more customers try your product and ask them to pick from a list of prices how much they would pay for your product.
If the market won’t pay enough to cover your costs and leave you with a margin you’re comfortable with, you might have to rethink your product, but if you have a quality product, they’ll likely pay more than what you thought.
Pricing is Fluid
Some products will generate huge demand. In that case, raise your price slightly. Others will not and you’ll transition those into liquidation pricing. Most businesses don’t want product sitting on shelves too long so don’t be afraid to cut your losses when something doesn’t work. Fill your shelves, virtual or physical, with moneymaking products that you can price for profitable margins.
Don’t expect to get it right the first time. Think about all of the products that companies with expert marketing teams put in front of the consumer only to watch them fail miserably. Owning a business is all about responding to what the market throws at you. As long as you’re doing that, you’ll find success.
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