3 Steps to Effectively Pricing your Products
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Today we’re getting right down to it. We’re answering the practical question that all product-based businesses ask when they’re first starting: “How do I price my products?” Below, we’ve given you 3 steps to consider when developing your initial pricing strategy.
Before we get started, though, it is important to mention that there is some trial and error that’s necessary when figuring out the right pricing for your products. So do the best you can, take the leap, launch your products, and then adjust your pricing as time goes on.
Let’s get to it: To put it simply, add up all the costs associated with producing your products and then add your profit margin on top of that to get your charging price. Easy, right? Keep reading to learn how to do this and why it’s effective:
1. Calculate your Variable Costs
The first thing you need to do is to add up all the variable costs for each of your products. These are the costs directly related to how many products you create/sell. If you order your products, then this will be more straightforward than if you create them yourself.
In order to calculate your variable production costs of the products you create, add up the bulk price of the raw materials used, and divide it by the number of products you can create with those materials. Don’t forget to include what you want to pay yourself for your time per product, packaging costs, and shipping (if applicable).
2. Add your Desired Profit Margin
Now that you have your variable cost per product, you need to add on the profit that you want to make for each product. To do this, divide your total variable costs by 1 minus your profit margin (as a decimal).
Average Price = Total Variable Cost ÷ (1 – Desired Profit Margin)
To see this in action, if the total variable cost of your product is $7.45 and you want to make a profit of 25%, then your formula would be:
Average Price = $7.45 ÷ (1 – .25) = $9.93 which you can round up to $10
When figuring your desired profit margin, make sure to consider these two things:
You haven’t added in your fixed costs yet, which are all the costs that you have to pay regardless of how many products you sell. Ideally, you want the profit you make from your products to cover these fixed costs as well.
Take a look at your market and make sure that what you are asking is a price that your customers will be willing to pay. You may want a high profit margin, but if that makes your product 2x more expensive than your competitors, you may suffer in the long run due to lack of sales.
3. Calculate your Fixed Costs
Your fixed costs are all the things you need to pay regardless of how many products you sell. These would include things like storage, salaried employee wages, website development, etc. In an ideal situation, you want the profit from your product to cover these fixed costs as well.
The easiest way to evaluate whether your profit will cover your fixed costs is to use this break-even analysis spreadsheet from Shopify. Enter in all the numbers that you’ve already calculated (Variable Costs and Average Price) as well as all your fixed costs. The spreadsheet will then calculate how many products you need to sell in order to break even. (For detailed instructions on how to use this spreadsheet, click here.)
Adjust as You Go
Like anything in your business, your pricing is not fixed. If what you’re doing isn’t working, don’t be afraid to adjust. With accurate bookkeeping, you’ll be able to see correctly the financial position of your business and what adjustments you need to make. Lucky for you, we’re experts at that kind of thing. Contact us today to receive your first month of bookkeeping support free!
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