This is the English version of a blogpost published on February 16th 2014.
How to compose the price of my products or services?
At a recent conference I gave on the analysis of business ideas using the GrowthWheel tool, a participant asked me how she could estimate her production cost to ask an investor for funds. Given the time allotted to my presentation, I could not answer him in detail. I would like to take the opportunity offered by entreprepreneurethnik.com site to address attitude questions (raising community awareness) and habilitation questions (empowering entrepreneurs) to make a short reminder.
Of course, it will mainly be cost accounting and cost sequencing and those who are experienced in management methods or will see no interest. I want to make sure that this concept is at least understood by a person wanting to go into business and who does not have an MBA in his pocket (if it is a relevant reference). The assessment of stocks and other concepts like the incorporation of certain charges will not be underlined because I want to keep it simple here.
That said, three steps are necessary to compose the price of the outputs of our activity: describe the production process, establish the nominal sale price and present the price to the customer.
I. Describe the production process
Most entrepreneurial activities are either commercial activities (purchase and resale) or production activities (goods or services). It is good to imagine the process we follow to make a profit in order to know the value of the product at each stage. Take the example of a hair product manufacturing. It involves a stage of research, supply, production and distribution. Each of these stages corresponds to direct costs which must be considered in addition to the notions of stock values and certain indirect costs (administration, promotion, organization, research and development, etc.). Here the most important is to draw a clear diagram of its manufacturing process (in tree structure or diagram) then we will indicate the unit cost (if possible) throughout the process up to the nominal sale price.
II. Establish the nominal selling price
The sale price is the sum of the cost price of the product (what we cost in total the production of the goods or service) and the margin. This margin can be arbitrary or adapt to the market. If the market imposes a price that most competitors respect then the effort must be made to reduce costs and costs internally or to justify a different price (niche). Basically, the cost price is determined from the production cost. The latter is determined from the purchase cost.
Indeed, the purchase cost is established from the purchase price of the raw materials used in the process; for example in the composition of our hair product. We add to it all the costs resulting from the activities that were necessary to make the purchase: canvassing, transport, customs, handling …
Then the production cost is established by adding to the previous purchase cost, the costs of the activities undertaken to produce the good or service. Essentially the salary of the employees and the direct cost of using machines (especially energy or rental costs).
Finally, the cost price is equal to the previous production cost plus the costs of the activities undertaken for the distribution of the product. For example: Postal or other delivery service, staff, packaging, processing of customer information, travel costs to attend an exhibition, etc.
You can now determine the funds to ask your investor for working capital or other, or add your margin to present the price to the client.
III. Present the price to the customer
At this stage the technical part of determining the price is carried out. You can tell if you are losing money on an offer or not. I recommend to those offering services to quantify their work: note the number of working hours, the number of words translated or generated in a report, the mileage during travel. Too often service offers are made with a ladle or squint on the neighbor. Presenting the price to the customer is a matter of attitude or skill. Whether you present your offer as a flat rate or at an hourly rate, if possible include cost price and a minimum margin as a basis. The additional margin can be made on a nominal basis or in the optional services to be offered to the client. This one will be less frightened by the prices that you proposed. Take the market into account, but also take into account your value to determine your price list.
Let’s take two examples to finish:
First case. The cost of a hair relaxant is CAD $ 5.00 you think you will produce 1000 per month. Your working capital is over three months. You can easily request CAD $ 15,000.00 from your investor plus a contingency of CAD $ 3,000.00 for charges due to operations. You have a first loan of CAD $ 18,000. You define a unit margin of CAD $ 3.00. You sell an average of 500 a month at the start, or CAD $ 4,000 of income. Rest assured nothing is hopeless it is time to analyze what is the reason for this deviation from the market research to which you have spent little time (this is often the case in ethnic entrepreneurship). One will wonder for example if it is the right market segment or if your margin is justified before undertaking marketing operations.
Second case. You offer an image management and social media presence service. In the description of your production process you must identify how long (day in the week or hour in the day) each of the activities you offer takes you. Set your hourly rate for these activities. Create basic packages comprising each of these activities (by type of service). Compare yourself to the competition and readjust. Put as an option those that make your value and what will make your additional margin: your writing style, your knowledge … This is what differentiates you and justifies that your service is offered at a different rate from your competitor. Anyone can charge 5 posts per week (basic package) but add publishing costs to your rate if you write these posts yourself without just copying and pasting links …
Here, I hope that these lines will have helped you to better understand the mechanics behind the definition of the price of a good or a service and do not forget that there are only those who do nothing who do not make no mistake. Pricing grids can be updated and if you operate by projects you have more flexibility to personalize each of your offers and learn from past experiences.