Setting Price Starts With Cost Anatomy

‘The Price is Right” was a television show that survived for years by giving people a chance to guess the right price for merchandise and services. Many business owners still play this game, but with much higher stakes.

Q. I’m in the final stages of starting a business which will offer a variety of consumer products, some of which I produce myself and some that I buy overseas. I’ve got a pretty good idea what I’m going to charge for my items but, I must admit, most of my prices were set “by Kentucky windage.” Is there a more “scientific” way of establishing my prices?

A. “Scientific” might be a stretch, but there surely are a number of important factors you should consider before going to market with a price list. The three most popular approaches - in order of their use by entrepreneurs - are cost-based, market-related and competitionconditioned. Frankly, any wise entrepreneur should take into account all three techniques before publishing prices.

Most venturers simply try to cover their costs and capture a fair profit. But to do this you must have a clear understanding of all of your costs. If you purchase finished goods from other suppliers, your costs are fairly apparent. However, don’t forget shipping, bank fees, discounts you might have to grant, allowance for damaged merchandise, etc.

If you manufacture your products you’ll have to track, very carefully, the costs of labor, materials, and direct overhead (like rent and utilities) that are associated with each item. Don’t forget to add in all of your indirect expenses that are related to things like office operations, marketing, utilities and interest.

You’ll have to estimate the volume you will handle for each item in order to allocate the costs appropriately. Remember, each item you offer should have its own cost anatomy. Using averages and applying them to all items will lead you dangerously astray.

Your costs will be both fixed and variable in nature. The fixed variety are those that will be there no matter how much you sell. The variable costs are those associated with each item (such as screws, paint, hours of labor, packaging, etc.). Your total variable cost will be a result of the number of items you produce.

To a product’s total fixed and variable cost you must add the profit desired in order to determine the price you will charge distributors, wholesalers or other end-users. Assuming you want a certain percentage of profit, you can use this formula to determine the wholesale price you should charge (e.g. costs/1.00 -.10 ), if 10 percent is the profit margin you want).

At this juncture you should determine the “break-even point” for each product you intend to offer. A simple formula will tell you how many of a given item you will have to sell in order to reach the point where you start making money.

If a product’s break-even point is beyond the sales volume you estimate for that piece of merchandise, it would be wise to reconsider offering that product unless, of course, you can whittle down your costs or increase your price.

Here is where you’ve got to give consideration to the market’s tolerance for your price. And, keep in mind that what the customer will be asked to pay is going to be a lot more than what you charge the wholesaler. The middleman will probably mark up your item another 50 percent to cover his price and profit, and the retailer will most likely double that figure to determine what he has to charge to stay in business.

So, if a product leaves your dock with a $5 price tag, the consumer could be asked to fork over as much as $15 for it. At this price, will it sell? Or will you have to go back and rejigger your costs, profit expectations and first-level pricing?

Getting a good handle on what the market will bear is important, because you might even conclude that your gizmo is good enough to demand more than the ultimate sales price you figured.

If your product is not one-of-a-kind, the third pricing technique comes into play. Examine the prices of similar or identical products in the market. If your packaging, quality, follow-up service, or general “shelf-appeal” don’t give you a distinct edge over the present players, you’ll have to bring your price in line with those your competitors are charging.

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The following fields overflowed: CREDIT = Paul Willax The Spokesman-Review