Business management is frequently faced with making decisions about price. How will I set prices? What should pricing accomplish? What about “loss-leaders”? What about sales promotions? Is it time for an increase? What about discounts?

Of course, the “trick” in establishing company pricing is to have the customers pay for all costs and remain competitive. The Owner ! Me!

Product pricing usually begins with cost … Company costs include: Direct Costs Overhead Expenses Debt Service Ownership Rewards Reserved Earnings Non-business Expenses

Labor and material costs that go into making the product plus freight-in and changes in inventory. The “indirect” business costs including: payroll, space costs, equipment rental, supplies, utilities, advertising, telephones, fax #s, insurance, repairs / maintenance, professional fees, postage, taxes, fees / donations, vehicle expense, and “other”. Interest on loan payments are included in “other” business expenses. Note – loan “principal” payments are not deductible expenses but certainly impact cash flow. It’s why you’re in business. What’s a fair return? Money earned and retained in the business for future needs like building repairs or capital assets. Money spent on non-business items … when the owner’s spouse takes $80 out of the register for groceries or car tags for the kids.

Let’s say the “direct” costs for this sport coat are: $52.05 $74.00 $ 2.00 $128.05

Many businesses establish price by applying some “mark-up” to the product’s direct costs. Other companies suggest a list price and then use a “multiplier” of the list to set prices. For example - Company: Ajax Tailors Product: Sport coat Direct cost: $ Mark-up: 140% Product price = $ If the trick is for price to cover all costs! We have to know the cost structure of the business.

Performance: Monthly average last 6 Months & planned performance for next 12 months. Revenue: $ 27,600 Cost of Sales: 11,500 Gross Profit: $16,100 Overhead: $8,200 Other: 900 Oper. Income $ 7,000 Taxes $ 1,850 Income $ 5, % 58.3% 25.4% Monthly Average The business needs $16,100 in gross profit each month to pay “overhead” expenses, debt service, taxes, provide a fair return to ownership and keep some $ in the company. 18.6%

Care more about profitability than how much stuff you sell.

When things don’t go as planned … and they won’t … keep the focus on profit. That’s why your in business. the volume of gross profit dollars that pays for all the other business costs.

When companies experience an unexpected decline in business, the temptation many times is to lower prices to stimulate sales. Before making any adjustments in price, answer these questions. 1. Is the decline short or long term? 2. Is the decline industry wide? 3. What are competitors doing? 4. What are vendors doing? 5. What’s the level of stock? 6. Is demand still healthy? 7. What are non-price options? 8. What’s the company’s financial position? 9. Are there untapped markets? 10. How much “sale” business do you need to hold gross profit levels?

How much “sale” business do you need to hold gross profit levels? That’s the first question business owners should asked when thinking about a sales promotion. Sales promotions can be an effective means for marketing your business. BUT discounts are at best a very short-term tactic.

Price discounts should be your last option to pay bills.

Let’s start with a simple concepts … $2.00 / unit x 4,000 units = $8,000 $8,000 - $4,000 = $4,000 50% = $4,000 / $8, % = $4,000 / $4,000

Are there “rational” limits to the discount amount?

Let’s use the Wheel – Start with direct cost $64.27 Define mark-up 100.0% Calculate price $ (cost x mark-up) + cost Calculate gross profit $ $64.27 (price – cost) Calculate gross profit % 50.0% (g p $ / price) Define Discount 40.0% Calculate new price $77.12 (old price – (discount x old price) Calculate new g p $ $12.85 (new price – cost) Calculate new g p % 16.67% (new g p $ / new price) Sales volume needed to yield original g p the new price $ (original g p $ / new g p %) Percent change 200.0% (new price / old price) - 1 What about a 125% mark-up and a 50% discount?

Wheel Methodology – Start with product cost $64.27 Define mark-up 125.0% Calculate price $ (cost x mark-up) + cost Calculate gross profit $ $80.34 (price – cost) Calculate gross profit % 55.6% (g p $ / price) Define Discount 50.0% Calculate new price $72.31 (old price – (discount x old price) Calculate new g p $ $ 8.04 (new price – cost) Calculate new g p % 11.12% (new g p $ / new price) Sales volume needed to yield original g p the new price $ (original g p $ / new g p %) Percent change 399.6% (new price / old price) - 1 What about a 125% mark-up and a 60% discount?

Wheel Methodology – Start with product cost $64.27 Define mark-up 125.0% Calculate price $ (cost x mark-up) + cost Calculate gross profit $ $80.34 (price – cost) Calculate gross profit % 55.6% (g p $ / price) Define Discount 60.0% Calculate new price $57.84 (old price – (discount x old price) Calculate new g p $ $ (new price – cost) Calculate new g p % % (new g p $ / new price) Sales volume needed to yield original g p the new price ?????? You can’t make it up in volume!

Price increases have the opposite effect… Increasing gross profit rates… The concern is the possible loss in business!

Wheel Methodology – Start with product cost $13.53 Define mark-up 100.0% Calculate price $ (cost x mark-up) + cost Calculate gross profit $ $13.53 (price – cost) Calculate gross profit % 50.0% (g p $ / price) Define Increase 13.0% Calculate new price $30.58 (old price + (discount x old price) Calculate new g p $ $17.05 (new price – cost) Calculate new g p % 55.76% (new g p $ / new price) Sales volume drop to yield original g p the new price $24.26 (original g p $ / new g p %) Percent decrease (new price / old price) - 1

This is only a tool to help business owners make better decisions. Price changes impact company profits. The Wheel can estimate the impact of future price changes – a before the fact evaluation. That’s Important!