Business owners and managers make a lot of difficult decisions. Setting prices falls into that category. Fortunately, there are only two factors that need to be considered when setting your price - (1) margin, and (2) what the market will bear.
Margin (or margin contribution) is what is commonly called "gross profit." Gross profit is the difference between selling price and the cost of goods sold. It is the "contribution" that you have to cover overhead and (hopefully) have enough left for profits. Here is an example. If you sell an item for $10.00 and it costs $3.00 of material and $2.00 of labor to produce, your cost of goods sold is $5.00 and your gross profit is $5.00. For each item that you sell, you have $5.00 to put toward paying your overhead and for profits.
Your overhead (rent, insurance, utilities, etc.) stays basically the same each month. Assuming your cost of goods sold per item stays the same each month (your supplier does not increase the price of the material and you do not give any wage increases), your gross profit goes up or down based on the volume. Thus, the first area to examine is how many items you need to sell at a $5.00 margin or gross profit to cover your overhead. If your overhead is $5,000 per month, you would need to sell 1,000 items to break-even.
That's arithmetic. It is the easy part since your costs are a known (or easy to forecast) factor. The difficult part is determining what the market will bear for a price. Are there 1,000 customers every month who are willing to pay $10.00 for your item? ......or are there 2,000 customers willing to pay $7.50 every month? ...... or 5,000 customers willing to pay $6.00? How many customers are willing to pay MORE THAN $5.00 (your cost of goods sold per item) for your item? That is the difficult question.
If you are selling a product or service that is currently being sold by other companies, you know what their customers are paying. That may make setting the price easier, but your challenge becomes getting those customers to become your customers.
If you are selling a new product or service, setting the price becomes more difficult. You need to do some research. You may need to take some surveys. You may want to compare the features and benefits of your product with the closest existing substitute and then adjust accordingly.
When you finally arrive at a starting price, it is wise to start a bit higher rather than lower. It is easier to reduce a price to generate more sales than to increase it to create more margin. If your price is too high, customers are faster to respond to a reduced price. If it is too low, you may lose too many customers when you increase the price.
Unfortunately, there is no exact formula for setting a new price. Some trial and error is involved. Just remember, it is better to err on the high side.
Those are my thoughts on setting prices. I welcome your commetns.
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