Pricing is probably one of the most difficult aspects of the marketing plan for a small business yet the most crucial, if a profit is to be made. It may be particularly difficult for women in business, because we seem to struggle more with our personal ‘worth’ in an economic world than men do.
That, however, will have to be the subject of another article. This one will assume that you are ‘beyond all that,’ and prepared to price your product or service based on established business practices – without guilt or apology.
There are two general ways to approach pricing. Both are equally valid, but for completely different reasons. In order to determine which road you will take, it is necessary to understand the assumptions and logic behind both of them. And regardless of which avenue you choose, each includes some elements of the other one.
The two most common pricing methods are:
— Cost pricing
— Market pricing
COST PRICING. In order to determine the formula you’ll use for cost pricing, two kinds of costs must be taken into account:
— FIXED COSTS – the costs that generally don’t change over the course of a year (labor rates, insurance payments, rent, equipment leases, etc.)
— VARIABLE COSTS – these are costs that are more difficult to determine over time, such as raw materials or supplies, and advertising costs.
In order to best illustrate cost pricing, I’m going to lead you through a real-life example from my business history. “Once upon a time,” I owned a balloon store in a local mall. I retailed party supplies and novelty gift items, and provided a decorating and party planning service, but my ‘staple’ was a basic balloon bouquet, and I had to determine how to price it.
The balloon bouquet consisted of seven latex balloons and one mylar (foil) tied together with ribbon to a weighted base. Follow me now as I lead you through the pricing process…
Latex balloons come in packages of 144 (12 dozen, called a ‘gross’ of balloons). Let’s say that the average cost of a gross was $20. Seven balloons would only be 1/20 of that cost, or a total of $1. The mylar balloon, on the other hand, was more expensive – the average cost of a single foil was $1.30.
The helium to fill the balloons was another story – by dividing the cost of a tank of helium by the number of balloons it would fill, I determined that my helium cost per balloon was about $.50. Eight balloons at $.50 equals $4 worth of helium.
Then I need ribbon to tie them all together. By dividing the cost of a spool of curling ribbon by the number of balloons I could tie up per spool, I determined that each bouquet’s ribbon cost was ten cents.
Let me diverge here for a moment, and talk about this ten cents. You may say to yourself, “Oh, for heaven’s sake, I’m not going to take every darn dime into account.” Well, I’ll tell you what – if I sell 6 balloon bouquets a day, 6 days a week, 365 days of the year, and I don’t take that dime into account, at the end of the year I would have thrown away $131.40! Are you willing to do that?
Okay, back to the balloon bouquet. I just need one more thing now to complete it, and that’s the weighted base to hold it all down. I used a variety of weights, depending on whether the bouquet was for a child’s third birthday, or for a centerpiece at a very posh wedding. I always purchased weights by the carton (or in some form of ‘bulk’), and my average cost per weight was $.50.
So … how much has it cost me to put together this basic balloon bouquet so far? Looks like $6.90 to me!
Now I have to determine labor costs. In order to do that, I have to take into account two things:
–What am I worth?
— How long does it take to make a balloon bouquet?
I decided that I was worth $12 per hour, and I knew that I was capable of putting together 6 balloon bouquets per hour. So what was my total labor cost for one balloon bouquet?
If you said $2, you’re catching on! So now the cost of the balloon bouquet has risen to $8.90.
But wait – I have overhead expenses! Rental on my little shop at the mall, all-inclusive, was $1000 month. (And this was ten years ago!) In order to make each balloon bouquet pay its share of my ‘piece of the rock,’ I had to determine two things – how many balloon bouquets I would sell in a month, and what percentage of my total business consisted on balloon bouquets.
My calculations determined that fully 50% of my over-all business came from balloon bouquets – so they needed to pay for 50% of my rent cost. In other words, $500. And, as I mentioned earlier, I sold (approximately) 6 per day – at 31 days per month, that’s 186 bouquets monthly. If you divide $500 by 186, you’ll discover that the ‘overhead’ cost to be added to each and every balloon bouquet was $2.15.
Still with me? If so, you know that the cost of that balloon bouquet has now risen to $11.05.
I’m not done yet. Now I have to determine an approximate cost for all my other fixed and variable business-related monthly expenses – car insurance and fuel, taxes, freight and delivery expenses, etc., etc.
I calculated that all other biz-related monthly expenses came to $375, of which those balloon bouquets had to pay half, or approximately $1 per bouquet.
So the final cost calculation for a single balloon bouquet comes to $12.05.
Now here is another place where women tend to err in their pricing decisions. We are tempted, now, to sell that balloon bouquet for about $12, because we’ve even taken into account a generous amount for our labor.
We’d be sorely cheating ourselves if we do. Indeed, $12.05 is simply the break-even price for that balloon bouquet.
I don’t know about you, but I went into business to make a PROFIT. I’ve made the investment, I put in the long hours and the sleepless nights, I take the risks – I deserve a profit! If I just wanted to make a wage, I can go to work for someone else!
Besides, particularly if your business grows to the point where you decide to hire help (as mine did), then you need to cover that labor cost – it’s not going in your pocket then, AND you have the added responsibility of an employee.
So … would you like to guess at what I sold that balloon bouquet for now?
Every industry has a “mark-up,” which is dictated by several factors – some of which we’ll look at more closely in a minute. I decided to make my mark-up 75% — so the balloon bouquet retailed in my store for $21.95, giving me a gross profit of $9.90 per bouquet.
Sounds good, doesn’t it? That means that I made a clear profit of $1675, monthly, on those balloon bouquets. With no apologies or guilt. Know why? Because most self-employed folks don’t have medical (or even sick leave) coverage, or pension plans, or daycare subsidies, for example. And remember – it was my investment, and my risk. And my business prospered.
Notwithstanding the cost formula outlined above, another method for calculating price for goods and services is simply by determining “what the market will bear,” or market pricing. Market pricing takes several factors into account:
Product availability. Simply put, if you are the “only game in town,” you can charge more.
The economy. People with more money to spend, spend more money.
Perceived value. If people assume your product is worth more than someone else’s, they’ll pay more.
Remember a few years ago, at Christmas, when parents all over the planet were desperately seeking “Talking Elmos” for their little darlings for Christmas? Well, based on the cost price formula above, Talking Elmos might only have been worth $25 – but because of availability (they were suddenly scarce) and perceived value, they sold for over $60, as I recall.
Essentially, based on market pricing theory, if people were not willing to pay $21.95 for my balloon bouquets, then all the cost formulas in the world wouldn’t have mattered. On the other hand, if you have a product or service that is unusual or unique, you can probably price it according to what the market will bear.
For example, during the time I owned that balloon store, I also planted pink flamingoes on people’s lawns in the middle of the night – a practise that was all the rage in the early 90s. The community I lived in LOVED this idea, and because they knew that I had to be up at 3 a.m. to pull it off, they gladly paid LOTS for that service. Based on cost pricing formula, I should have charged about $35 for the service. Based on market pricing, I charged $85 – and never once had a shortage of customers willing to pay! And I charged that without apology or guilt – because at 3 am., I was taking risks that no one else in the community was willing to take!
There are many other factors that may effect your pricing decisions – amount of competition, customer loyalty, seasonal variations (ever notice how the price of a dozen roses goes sky-high at Valentine’s?), but all of them will still boil down to those two main pricing processes, or a combination of the two – either by cost, or according to the market.
Good luck with your pricing decisions – and don’t apologize or feel guilty once you’ve determined them!
Author Marilyn Guille owns Comprehensive Virtual Editing (CoVE) Services, which provides press release writing and distribution, general and business writing, editing, and ghostwriting services. Guille has been a professional freelance writer for two decades, and lives on a classic boat on which she and her husband do sightseeing charters. You can check out her website at http://www.coveservices.net