Pricing your products for profit is a mix of science, experience, knowledge and guesswork.
The science part is the formula. There are 4 components in the pricing model formula: materials, people’s time, distribution costs and margin. For those who love equations the pricing model is:
- Cost = Materials + People + Distribution
- Price = Cost + Margin
Cost is what it costs your company to make and distribute. Price is what you sell it for.
To determine the true cost of your product you must do your homework. You must identify every component and accurately put a price on each. What follows is a checklist of common components to get you started.
Whether you sell physical products or services you will have material costs.
- Supporting materials such as instructions
- Raw materials; the cost of the tree to make the table
- Cost of buying the product from China; manufacturing plus shipping costs
- Your cost when buying from a supplier
- License/royalty fees
- Regulator/government fees; e.g. recycling fee for electronics
- Manufacturing costs
Hourly cost; pay + benefits = hourly costs
Sometimes part of the margin; sometimes added with margin included
- To make the product
- To deliver the service
- To provide support
- To inspect products before shipping
- Third party shipping costs; e.g. couriers
- Delivery costs; i.e. your cost to deliver – van, driver, parking tickets etc
- Air freight
- Cross border duties
If your product is web based do not forget to include the technical infrastructure in the cost; servers, software, maintenance etc.
This is the profit you must make on each item so that the total margin of all things sold covers your operating costs and gives you the required return. And the selling price must be acceptable to the market. This is the secret sauce of business success.
Don’t forget to revisit the cost and profit of your products on a regular basis? Things change; your costs can fluctuate with exchange rate changes (up or down) or increases in the cost of raw materials such as gas prices. You reward your team with pay raises; that will increase your costs. So make it a habit to revisit your pricing models at least every 6 months and even more if your business is dependent on exchange rates. For example, if you buy from the US or export to the US you will need to monitor exchange rates closely.
Did you find the information useful? Purchase our book “The Three Pillars of Financial Management™“. Click here!