Every product has its price, whether it’s a high-end computer or a coffee mug – but determining those prices can be a challenge for any business. It comes down to a constant balancing act between profit margins and the price your customers are actually willing to pay.
In order to find out what price the market will bear, you’ll have to be honest with yourself about what products or services you offer. If they are truly unique offerings, then you have a great deal of flexibility when it comes to pricing. This doesn’t mean you can set them arbitrarily and expect huge profits, as today’s price-conscious consumer is extremely sensitive to high price tags, but you won’t need to immediately compete in the marketplace. However, establishing an extremely high profit margin for a unique product will inevitably cause other manufacturers to duplicate your product and undercut your pricing scheme – one only needs to look at the current rivalry between Apple and Samsung in the smartphone and tablet markets to see an example of this process in action.
If you’re considering competing in a market that is already well-established, as is usually the case, then your pricing structure has to be modelled off of that of your competitors. In order to determine whether or not this will be profitable, you have to closely examine your profit margins for each product or service you plan to offer. There are three main calculations you’ll need to consider: direct cost, break-even product pricing, and profit margin pricing.
Simply put, direct costs are what it actually costs you to purchase the product from a manufacturer. If you are the manufacturer, then the direct cost is the cost of the materials required to produce your product, including the labour cost of any employees. If you’re selling at the direct price, you’re essentially saying that your time and energy have zero value, so avoid this.
Break-even product pricing is the direct price plus a percentage of your overhead costs, such as rent, electricity, and other necessities that come with their own price tag. If you can sell at the break-even price point, then at least you’re not losing any money – but you’re definitely not generating a profit, either. Break-even product pricing might be useful if it entices customers to purchase other products at the same time that come with a high profit margin. One common example of this is the North American practice of mobile providers offering smartphone discounts, provided the customer also signs up for a three-year contract. The company “breaks even” on the cost of the device, and then has 3 years to generate profit on the services that must be purchased with the smartphone.
Finally, there is profit pricing – this is where the real money is generated! Profit pricing takes into account your direct costs, overhead costs and your desired profit margin. If you can sell at your chosen profit price and still stay competitive in the marketplace, then you’re on your way to success!