Pricing a product may be nerve-racking sometimes. It is one of the most crucial decisions since your profit largely depends on how you price your products. Sometimes, a business that produces great quality products may not see expected results due to the wrong pricing strategy. Pricing has both subjective and objective aspects. You have to make judgments based on qualitative and quantitative information. Quantitative and qualitative analysis can be effective in choosing the best price for your products.
So we are going to talk about both of the aspects. But let’s try to debunk the pricing puzzle simplistically so that small businesses like us can price their products more effectively. We can use a simple markup method. We also talk about the CVP analysis. It is basically a relationship between cost, volume, and profits. It is pretty simple. Let’s start the step-by-step discussion.
It is one of the easiest methods to determine the sale’s price. All you need to do is to calculate the cost of goods sold. The cost of goods sold is basically the cost to produce the products that you intend to sell. When you determine how much it takes to make a product, you will just apply the mark up to find out the selling price per unit.
For example, you want to sell your products at 20% mark up. So as you the cost of goods is CU100. So your selling price per unit will be 100*20% = 120.
Determine the sale’s price from the desired sales volume and target profits
Sometimes you have desired sales volume and target profits. But you don’t know how much the sale’s price would be to attain these quantitative operational goals. This method would be effective as it helps to determine the sales price using CVP analysis.
Step 1: Gather all the information
The first task is to make a note or list of all the costs to produce the product. You surely have those in your notebook. You may have noticed that some of your costs don’t actually change as activity changes. They remain fixed. So, we will call them fixed costs.
On the other hand, some of them change while the activity changes. They don’t remain the same rather they vary. So we call them variable cost. Giving an example would be better.
Suppose, you’re an owner of a coffee shop. To run a coffee shop, you have to pay rent. Then there is the insurance bill. You see, there is a similarity between these costs. You have to pay at the end of the month or any particular period. It does not matter how much you are selling. Even If the shop is even closed, you do have to pay the rent. Thus they are fixed costs.
On the other hand, you have purchased beans (raw materials). Two guys are working on a wage basis. So the increase or decrease of these costs depends on how many cups of coffee you are selling or how many days your business is active. The more you sell, the more materials or labor you need. So they are variable costs.
So my point is to separate the item of costs in accordance with their reaction towards the activity.
Step 2: Decide your required sales and target profits
This part is a bit tricky. Check your previous sales and profits. You can get an idea. Here, a good analysis is required. Make a thorough analysis of market demand.
Let's say, you wish to sell 16,000 units of product and want to make CU25,000 at the end of the month. The variable cost is CU240,000. The fixed cost is CU50,000.
You just need to determine each unit’s sale’s price. It’s pretty clear that your every unit’s variable cost stands at CU15 er unit since you divide the total variable cost by the total number of units you wished to sell.
Let’s open an excel sheet. At first, we need to know the required contribution per unit. As we know what our target or required profits is, we just simply add the fixed costs to find out the required contribution. When you find out each unit’s required contribution is how much, you have to add your variable cost with the required contribution per unit to determine the sales price per unit. Yes, that’s it.
Understand your competitors
When you know exactly how much it cost to make a product, you can set the price in accordance with your wish to make a required profit. But you can’t just simply ignore the existence of your competitors. Understanding the competitor is significant to earn required revenues.
Knowing the price of competitors’ goods is not enough. As price varies with product quality, brand factors, delivery system, promotions, discounting structure, procurement structure. So you have to identify with whom you are competing.
Some of your competitors may be industry giants who dictate the market. Run a SWOT analysis. Find their weaknesses. Make their weaknesses your strengths. If you solely follow the price of your industry leaders, you may not find effective results. After-sales service, great customer care, and quality products should be factors affecting your price.
If you find your competitors are almost identical, analyze their pricing strategy. It might tell you to recheck your suppliers, distributor channels, promotion mediums if they provide lower costs than yours.
Analyze the market demands
There may be of off-peak periods where the demand for the products is substantially low. You can lower the price to generate more revenues. On the other hand, you can slightly raise the price in the peak season so that the decrease in price in the off-peak season would not hurt your profitability. It’s about balancing the profit. Maintaining consistent prices would generate obsolete products as you cannot sell the products in off-peak season.
Know your Customers
The customer is one of the most important stakeholders in your company. So you have to identify who your customers are, how they are likely to respond towards the fluctuations of price.
Before determining the price you need to take into consideration of customers’ expectations. The deviation between expectation and reality would cause a significant effect on profitability. If you don’t consider customers while setting the price, you lose your loyal customers to your competitors. So, respect the customers’ expectations.