By Bryan Orr
Pricing is one of the more hotly disputed topics in the business world. If you price too high, you are called a “rip-off” or a “scammer.” If you price too low, others in your trade might accuse you of “undercutting the competition,” using questionable labor, or worse, you could go out of business.
All of the childish name-calling aside, you should have two primary objectives:
- Price high enough that you make a consistent profit after paying yourself, your staff, your operating expenses and any regular capital expenditures (vehicles, repairs, renovation, phone systems, computers, etc.).
- Price low enough that there is still sufficient demand for your product or service.
You will notice that I didn’t mention the words “fair” or “competitive” in the pricing objectives. The reason? Fair and competitive are totally subjective terms that cannot be measured. One person’s idea of fair may be numbers that you cannot make a profit with, and you shouldn’t be worried about another person’s arbitrary concept of fairness.
Think about these four questions when you start selling a new product or service:
- What are the direct costs of the product or service?
- What are my overhead and capital expenses?
- How many hours of work will it take from beginning to end in order to sell it?
- What do I hope to make in profit-per-hour of labor?
Many businesses figure pricing on a percentage-basis against the cost of the product or service. This works in some cases, but it usually doesn’t scale well. As a result, a business that thinks it is profitable, actually loses money once everything is factored in.
Grade school math can help you with accurate pricing. How can you figure your actual profit if that method doesn’t work? If you can figure out how much each labor-hour costs you as a company, reverse that to figure how you might need to adjust your pricing.
- Take last year’s total labor hours worked in the business. (Your hours + all employee hours = total labor hours.)
- Take all of your expenses from the previous year, subtracting from that number from ONLY the Cost of Goods Sold (cost to you).
- Now divide your total expenses by the total hours worked, and you will have a legitimate Expenses Per Hour number.
Decide what you intend in Profit Per Hour of work in your business. This number is up to you and you shouldn’t be ashamed of it. Use that to figure your rate for labor and pricing.
- Add your Profit Per Hour number to the number of Expenses Per Hour to come up with a Retail Hourly Rate.
- Multiply your Retail Hourly Rate times Total Hours Labor to Sell.
- Add in the Cost of Goods Sold, and you have your Price for Product.
In some cases you will find that the there is not a demand for your product or service at the price you come up with initially. This could be because the pricing is too high, or it might actually be that the value has not been adequately presented. Research has shown time and time again that the value presentation is much more likely to be the cause as opposed to the price.
Fear is usually the reason that most businesses fail to charge what they must charge to make a consistent profit. While fear is a very useful emotion when a lion is chasing you through the savannah, it is not a good way to set pricing. The guy who calls you a “ripoff” is not a lion — he is just a lyin’.
What issues do you see with this pricing model?