One of the most important elements of starting up your business is setting the price of your products and services. It is not an easy task and there are no fixed rules to follow, however, there are some useful guidelines that may help you.
First of all, you have to ensure that the price of the product or service will cover your costs. Compute your fixed costs. These are expenses which you will need to pay regardless of your sales level. Fixed costs include payment for employees’ wages, rent, and utilities.
After knowing your fixed costs, determine your variable costs. These are the costs of your purchases or the costs of rendering your services. The total amount of variable costs will vary or depend on the sales level of your business.
One of the methods in setting your price is cost-plus pricing. This is basically adding the markup on top of the price of your product or service as a percentage of its cost. This markup percentage which actually represents your profit can be identified by industry standards or by the owner himself.
This way of setting the price is usually used as it is relatively easy to compute although it might be hard to dictate prices as customers like comparing prices. In addition, they generally purchase or avail of products or services which they think are the best deal for them.
On the other hand, value-based pricing would be more difficult to determine as it would require estimating prices depending on how much customers would willingly pay for your product or service. You would need to do some market research or use trial and error to get a hold of this information.
Value-based pricing in its literal sense implies basing pricing on the product benefits perceived by the customer instead of on the actual costs incurred in producing and developing the product.
Under this approach, non-price elements like convenience, quality, service, fashion, and trends, are given more attention to increase the perceived benefits of the customers, which will then be used in setting the price.
Mark-up and Margin
Markup is the amount added to create a profit, onto the total cost incurred by the producer of a good or service. Mark-up is the percentage of the cost price.
Mark-up = Gross Profit x 100
Margin represents the profit percentage of the selling price that the company retains after incurring the direct costs associated with producing the goods and services it sells.
Margin = Gross Profit x 100
For instance, a shirt costs $120. You sell it for $200. The mark-up is 67% and the margin is 40%. (In percentage figures, mark-up is always higher than the margin for the same product.)
Mark-up = ($200 – $120) x 100 = 67 %
Margin = ($200 – $120) x 100 = 40 %
- Compute your fixed and variable costs and then identify your desired profit margin. Decide what suitable pricing strategy you will use.
One of the most important business strategies that you need to decide is setting your price. Your sales and marketing plans and activities should give more attention on increasing profits rather than merely increasing sales.
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James HuyVuong is a CPA and the owner of Your Accounting Partners. Partnering with businesses from start to scale thru to sale.