Various methods of calculating price for your product or service Pricing and costing Various methods of calculating price for your product or service

Decision on how much to charge for a product or service is one of the most difficult decisions in business. If your price is too high, you lose the sale; if the customer pays your asking price too readily, you feel that you have given the product away! Pricing is an important part of your Marketing Mix (Product, Price, Positioning, Promotion)

When we think about pricing we think of.... How to determine the price itself? Do we offer discounts? Shall we accept credit/debit cards? Shall we allow paying on instalments?

Payment terms and finances Whether you are offering discounts, accepting credit cards or allowing instalment payment, bare in mind that this will influence your monthly cash flow! If your competitors offer various payment terms, so will you have to adjust! For the instalment payment – your price should include interest rate, as big as the savings interest rate you would get if you have put that money in the bank For credit card payment – think of the bank costs and other possibly hidden costs occuring! State clearly your terms of payment (in the contract or invoice) – agree and charge penalties for late payment

When determining pricing policy think of: The market – your buyer will buy the benefits a product or service bring (how useful the product is for him/her!) and not the product itself. Also he/she will compare – price/quality of your product with the competitor. Costs – you should cover your costs and earn a profit. Charging the lowest price can be tricky – your product might be perceived as low quality!

Also, your price will be influenced by: Your costs – fixed (overhead) and variable costs. Your competition and their prices Your target customers and their characteristics Costs of your product The lowest price you can charge – price floor Sustainable for short period of time Competitors price Very good position if you can charge a profit and cover your costs If price is the same compete on non-price terms (helpful staff, faster service time etc.) Consumer’s perception of usefulness and satisfaction of needs The highest price you can charge – price floor Beyond this price there is no demand for product

Some methods of pricing your products/services Market pricing Cost-plus pricing Markup pricing Break-even method Note: the simplest method to calculate the price would be Price = variable costs + fixed costs + profit

Market pricing You charge at, or close to, prices charged by direct competitors. If you can make profit doing so, this is a very good method In order to make higher profits, you will have to concentrate on non-price distinctiveness to attract and retain your customers

Knowing your costs In order to charge any price, you have to know your costs Fixed costs (overhead costs) – the costs you have to pay whether you work or not (rent, utilities, loan, insurance premiums, etc.) Variable costs (direct labour costs and material used in producing e.g. product, they occur when you produce a product or service – 5 working hours per product, 3 kg of raw material, transportation costs etc.)

Cost-plus pricing This method suits situations where the seller does not know market conditions, such as in a start-up or entering a new market with a new product. Also used if you have a single product. The important thing is to know your variable and fixed costs, and desirable margin you want to earn If the costs are higher than the market price – you might be in trouble since no one will buy from you

Formula – Cost-plus pricing Price = Total Fixed costs Average variable cost (per unit) + Expected sales 1 – desired return on sales = MARGIN

Example If the average variable costs per unit are 10 euros and total fixed costs are 20.000 euros. What would be the price if expected sales is 100.000 units and the producer wants 20% margin Price= 20.000 10 + 10,2 100.000 = = 12,75 euros 0,8 1- 0,2

Markup pricing To total costs we add certain percentage – markup, to get a price The markup percentage is determined by the amount of your planned profit, the type of the product or service you are selling, how rapidly the product sells, and the amount of service performed by the seller.

Formula Price = Total costs per unit + % markup E.g. If Total costs per unit are 5 euros and desired markup is 30% then the price is as follows: Price = 5 + (5 * 0,3) = 6.5 euros

Pros and cons of cost-plus and markup pricing (Kotler, 2008, p.291) CONs - ignores demand and competitor prices. Wrongly assumes that prices can be set without affecting sales volume. It works only if the price actually brings in the expected level of sales PROs - sellers are more certain about costs than about demand. By tying the price to cost, sellers simplify pricing-they do not have to make frequent adjustments as demand changes. - when all firms in the industry use this pricing method, prices tend to be similar and price competition is thus minimized. - many people feel that cost-plus pricing is fairer to both buyers and sellers. Sellers earn a fair return on their investment but do not take advantage of buyers when buyers‘ demand becomes great.

Break-even method the practice of setting a price point (break-even point) at which a business will earn zero profits on a sale – to gain market share The concept is also useful for establishing the lowest acceptable price, below which the seller will begin to lose money on a sale. This information is useful when responding to a customer that is demanding the lowest possible price.

Formula – break even point BP = Fixed costs/ (Average price per unit sold (or working hour) – Variable costs per unit sold (or working hour))

Example – break even point You are thinking of turning your hobby of making designer hats into small business. Monthly fixed costs are 200 euros. Variable costs (labour, material) are 30 euros per hat. Average price on the market is 100 euros per hat (let’s say that VAT is 23% in this case, but it is not 23 euros you deduct but 18.7 euros since it is included in the price). Your BP is BP=200/(100-18,7-30)=200/51,3=3,9 Result: you have to sell 4 hats to break even, i.e. to cover all your costs.

Note on break even point This is the bottom price limit which will enable covering all costs with the incomes gained – good for short run! In the long run, it does not allow for new investments into business, it should be revised for a certain percentage of margin!

Final important note on setting a price These methods of price calculation are only a helping tool, and should go along with your overall marketing strategy and characteristics of your market!