About the Elements to Consider for an Adequate Pricing Calculation
Pricing
The price of your product or service not only has a direct impact on your business finances but also affects your image and positioning relative to your competition
A topic that often concerns many entrepreneurs is how to accurately calculate the price at which they will offer their products or services in the market. Being a fundamental topic for the economic success of your business, there is often a significant lack of understanding of all the implications involved in this calculation.
“The moment you make a mistake in pricing, you’re risking your reputation or your profit”
The price of your product or service not only has a direct impact on your business finances but also affects your image and positioning relative to your competition.
A price much higher than the competition may create resistance among your potential customers unless it comes with a clear superior value offering.
A price much lower than the competition may generate a perception of lower value, discouraging trial and preference.
Your prices must adequately cover your costs and, in addition, generate a profit margin; otherwise, they undermine the viability and sustainability of your business.
How to Calculate Your Prices?
In short, an adequate price calculation is vital and essential for your business's success, both from an economic standpoint and from an image-building perspective.
I don’t come from a finance or accounting background, but I have had to prepare multiple budgets and cost calculations for various projects and products throughout my professional life. So, with great humility, I share with you some elements to consider, which I have gathered throughout my experience and through the review and analysis of other expert texts, which I will share with you at the end of this article.
Your Price Essentially Includes Two Elements:
All your costs, and
A profit margin.
Sounds simple, right?
Why, then, is it sometimes so complicated to calculate the price?
Because cost calculation involves many variables. If you leave any out, your cost will be unrealistic, and therefore, your price will not be appropriate.
What Should You Include in Your Costs?
The idea is that each unit of product or service you offer should incorporate, to some degree, ALL the costs you incur. Here’s a list of items to consider. Of course, depending on your business, some of these costs may not be relevant or applicable. Once you review the entire list, you can determine what applies and what does not to your own business:
All materials and supplies required to manufacture the product or provide the service.
Office consumables.
Labor costs for employees you hire to work in your business, including all legal obligations to such personnel, such as social security contributions or any other legally required contributions in your country.
Your own salary. Though it may seem obvious, you’d be surprised at how many entrepreneurs I’ve seen who don’t include their own salary in the cost.
Fixed operational costs of your office space (or workshop, or any space dedicated to your business), which must be incurred regardless of whether you produce the product or service.
Professional services required to offer the product or service.
Marketing, sales, advertising, and distribution costs.
Travel and transportation expenses.
Legal expenses.
Financial expenses.
Unexpected expenses.
This list includes the most common elements that generally apply in one way or another to almost any business. However, some of these items may not apply to you, or you may have additional costs specific to your industry that I haven’t mentioned. In any case, it’s essential to break down all expenses in as much detail as possible. Any aspect you omit simply won’t be reflected in the price and will instead be absorbed by your profit, which will diminish as the omissions in cost calculation increase.
Profit Margin
Once you have calculated all your costs and converted them into the unit cost, you should then apply a profit margin. Here, you are free to apply a profit margin that you consider appropriate for your product or service and which is usual or standard within your industry.
Some sectors work with a 30% margin, others with 20%, and some as low as 5%. There’s no right or wrong here; you simply need to research your market prices, understand your competitors’ margins, and experiment with different scenarios until you find one that best suits your industry and generates profits.
Price Benchmarking
You’ve calculated your price. However, the process isn’t quite over. This would be, so to speak, the "ideal" price that covers all your costs and generates the desired margin.
Now comes the analysis and review part. You need to refine and determine if this price is appropriate for the unit of product or service, based on the current market offering and your competition. This process of analysis and comparison with the standard in your market is known as "benchmarking."
Is Your Price Below the Competition’s?
If so, analyze if you’ve excluded some costs that you aren’t considering. Assess the value of your offering and determine if your competitors are providing additional benefits that you don’t offer and that justify their higher prices. If your value proposition is equal to (or better than) your competition and all your costs are included, you might consider increasing the margin to raise the price. Alternatively, you may decide to maintain a lower price as a competitive advantage, but always bear in mind the risk of affecting your image.
Is Your Price Above the Competition’s?
In this case, analyze whether your value proposition is superior, with different and better benefits that justify a premium price. If you’re not offering greater value, you can review your costs to see if there’s a way to reduce the unit cost without affecting quality. You could do this by streamlining processes to produce more units monthly, so that fixed costs, when divided among more monthly units, decrease. You might also consider alternative suppliers for materials and services that can offer the same quality at a lower cost. If these adjustments don’t work, review the applied margin to see if you can work with a lower margin, bringing the price to more competitive levels.
Is Your Price Similar to the Competition’s?
If so, verify whether your value proposition is comparable. If your value offering is higher, you can consider raising your price slightly, and if it’s lower, you may want to review your offering or lower the price.
In any case, whatever your decision, it’s important to ensure four things:
You’re covering ALL your costs.
You have a profit margin suitable to your market and business expectations.
The unit price makes sense within your market, relative to the competition.
Whatever your decision, the value proposition of your product or service is consistent with the price you’ve set.
I hope these general guidelines are useful to you. As I mentioned earlier, this guidance comes from my empirical experience rather than professional training, so it’s possible that I may have missed some points. What other considerations do you take into account that I haven’t listed? Help other entrepreneurs like you with your comments.