To be successful in your new business, you must get your pricing right. Pricing is an essential part of your business plan. Statistics prove that over 46% of all start-up businesses fail due to incorrect pricing.
Get it wrong, and you lose money, get it right and make money. No worries, I am here to help teach you how not to be one of those failing companies. Read on about the correct way to determine your optimal new product or service price.
The number one mistake that beginning entrepreneurs make is to sell their product or service as cheaply as possible wrongly thinking that this is the way for them to gain new customers. They believe that because their products are so cheap that there will be no buying resistance and they will quickly make sales.
They believe that old business myth, I’ll make it up in volume. This concept is that when cutting profits, your increased volume of sales will cover the lower profit margins. It almost never works out because the more you sell, the more money you lose with each item. So instead of succeeding you just fail more quickly. This stupidity, making up the difference in volume, is one of the worst marketing mistakes you can make as proven by this case study.
These entrepreneurs forget that the object of business is to make money, actual dollars, not just sales.
Be crystal clear that your primary objective of your business is to generate profits. A business without profits is soon a failure statistic. Don’t listen to news stories of not needing to make a profit while you’re building your brand. Don’t believe these slick magazine articles they are not real life business experience.
You want to find your perfect sweet spot of pricing that both generates healthy profits and high sales. The saying sweet spot is a tennis term that is the perfect point to make contact with the ball for your best game. In business, it is the optimum position or combination of factors that spell success. Price your product high enough to make money for you and your firm and low enough for customers to purchase. The pricing sweet spot – that intersection of perfect efficiency and effectiveness – is a delicate and beautiful thing that takes some work, planning and thinking to locate. We’ll find yours together.
The worst part of pricing your product or service to low is that you will generate no profits and your business will not survive. Additionally, you create a low-value perception of your product in your prospective customer’s mind. This first impression, if not positive, will take a long time, and tons of advertising dollars to shift into the ability to charge more for your products – if it ever changes.
Rookie entrepreneurs think that a lower price will remove their buyer’s objection to placing an order. However, this often backfires, and customers think less of your product because it is too cheap. They say to themselves, how good could it be at that low price?
Alternately, pricing your products too high is going to slow your growth and give your competitors an unfair advantage. Also, pricing beyond your customer’s ability to pay will certainly decrease sales. Often new business owners price too high because they overestimate their costs, and underestimate their sales volume. It happened when the entrepreneurs created high overhead by purchasing expensive equipment, excessive setup costs, and over hiring too many employees. If you feel that your product price is not fair, and you would not purchase your product at the price you are asking then don’t expect your new customers to either!
Crunching the Numbers
First, I recommend to my business clients that they start by looking at their own production costs before they study their competitors’ pricing. I encourage this because this focuses them on the most important aspect of price determination which is to generate profit.
How to calculate your product costs and profit margins
To calculate your total COG (Cost of Goods) you need to add up all your costs to produce and deliver our product which includes, supply costs, assembly labor, rent payments, packaging costs and overhead fees, such as office supplies, advertising, and utility payments. Don’t forget those small fees that quickly add up such as credit card fees, inbound shipping for your supplies, stickers, and labels, electricity, telephone bills and other miscellaneous fees. Using a top quality accounting software such as our best for small business choice – Quickbooks Online makes it easy to get these vital calculations.
Another factor to calculate is shrinkage and waste. All businesses have losses such as broken bottles, wasted shrink wrap, and damaged supplies. A safe estimate is 10% of your total supply cost, not the total of all your costs just raw material subtotal, to be estimated to cover these contingencies.
When I developed the pricing strategy for my cosmetic line that I manufactured, I added a cushion of 10% to my overall product manufacturing expenses, in addition to the shrinkage expense, to act as a cushion to protect my profit margin against any forgotten expenses.
Your profit margin is your sales prices to your customers minus these expenses described above are your profit margin. It is often referred to as a percentage of your total sales price such as 24%
Remember that as a manufacturer your price is the price you receiving from your customer. They, retailer or distributor, will then add their own profit margin and sell to it to the ultimate consumer. As an example, you designed a fashion apparel line and charge $100 per dress to your customer, a brick and mortar boutique. That store will then add their own markup, usually 50%, and sell that dress to the consumer for $200. So your profit margin calculations need to be deducted from your $100 that is paid to you by the boutique retailer, not the $200 the customer in the boutique store will pay.
Your Industry Standard Profit Margins
Begin your competitive pricing research by studying your particular industries standard profit margins. This information will give you a general outline of your competitors’ profit margins percentages.
Here’s a chart of standard industry profit margin percentages in 2017 published by experts at the NYU Stern School of Business which lists margins by industry from Advertising to Utility, with lots of other industry statistics such as Apparel, business services, and food processing plus others.
You will discover that the Net Margin, that percentage of revenue remaining, after all, operating expenses and taxes have been paid varies from 6.29% in Apparel to 14.18% in computers.
There are different types of profit margins such as gross profit and net profit. Gross profit is the difference between the COG (product manufacturing costs only) and net profits is the both product manufacturing supply costs and overhead cost deducted from the sales price. Overhead costs include office rent, employee salaries, utility fees, advertising costs and other expenses.