Are you pricing your products right?
Factors you should consider
By: Entrepreneur Staff | Oct 26, 2011 14:00 pm
Pricing is one of the most important factors you must consider in whatever business you plan to put up. The idea is not to price your product or service too high or too low. If your price is too high, not too many people will be able to afford your product or service. If it’s too low, customers won’t buy it because they’ll think what you’re offering is of inferior quality.
There’s no hard-and-fast rule in determining the right price for your product or service, but there are a few things you’ll want to keep in mind before you do. One is the cost of your merchandise or service. At the very least, you’ll want to recover the cost of producing your product or service for every sale, and to know your recovery cost you must first determine the cost of producing it.
Your cost has two components: the variable and the fixed. The variable component comprises all direct costs related to producing your product or service, and these are usually your direct materials and direct labor that are directly proportional to the number of units you plan to sell. (Directly proportional means any increase in production will proportionately increase your variable cost or your cost of producing each unit, while any decrease in production will proportionately bring down your variable cost.)
Your fixed component is usually your indirect costs known as overhead, which is inversely proportional—meaning any increase in units produced will result in a lower amount of fixed cost per unit produced—to the volume you plan to sell. To simplify price-setting, make your operating costs part of your overhead so that your costs are all in when you compute for the selling price. Your cost will set the base in computing for your desired gross profit, which is the other factor to keep in mind when setting the price of your product or service.
Your desired gross profit is of course the amount of profit you’d like to earn for every product you sell or service you provide. This should set the minimum amount of profit you’d like to make in operating your business, and it may be expressed in pesos or as a percentage of your cost. (Use percentage of cost as this is easier especially when you need to raise your prices.) Your gross profit rate could range from 10 to 200 percent, but ideally it should be 20 to 50 percent. Keep in mind that all businesses are established with the ultimate goal of making a profit, and this is one area of your price setting that’s crucial to your success.
Also remember that your desired gross profit rate is likely to be influenced by your payback period. The longer your payback period, the lower gross profit and selling price you need to sustain your business; and the shorter it is, the higher your gross profit should be.
After coming up with your selling price based on your cost and desired gross profit—the quantitative factors—you may adjust it further using qualitative factors like the characteristics of your target market. If your target market is the upper class, you have room to price your product or service higher; if it’s the lower class, then you should bring it lower as price is a major consideration with its members.
Another factor to consider when setting your selling price is the industry to which you belong and its standards. (Do some research to determine exactly who your competitors are and what they’re charging for the same product or service. Then make it a point to price your product or service within their price range.) The image your want to project for your product or service is equally important. If you want to project your product or service as something superior, then price it a bit higher—though not too high—in relation to your competitors. If you want to project the image of being inexpensive, reasonable or affordable, then price your product or service lower. The key is in knowing what your market can afford or is prepared to pay for whatever it is you’re offering.
This article was originally published in the October 2005 issue of Entrepreneur Philippines.