Setting your prices for products and services can be tricky when you're starting out, so it's important to spend the time to get it right.
If you're working harder than ever but don't feel like you're getting anywhere, it's time to review your pricing strategy.
Many people have a tendency to sell themselves short, especially when it comes to valuing their time.
So hear this: there's no shame in making a profit from the fruits of your labour.
In fact, if you want to stay in business, then you need to earn a sustainable profit margin. It needs to be enough to sustain both you and the business, which can entail investing money back into the business to help it grow.
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1. Calculate the cost of providing your product or service
There are many types of small ventures in Australia but when it comes to pricing, they fall into two broad categories:
- Those that sell products
- Those that sell services
The product category includes tangible things like botanical hand soap, wedding cakes or handmade jewelry. The service category includes everything from carpet cleaning to legal and financial advice.
Here we provide advice and resources on how to set prices for services, as well as products.
Setting prices for products
As a starting point, it's essential to know how much it costs you to make the things that you sell.
When determining the costs of goods sold (COGS), make sure you include the total cost of production.
This doesn't just include the cost of the raw materials, such as wire and beads if you make jewellery, but also any manufacturing costs, including labour (see Pricing services below for how to put a dollar figure on the value of your time and skill).
Don't include other expenses that aren't directly incurred in the production of a product, such as office rental or your power bill here. We'll include these later as overheads.
If you sell a range of products, it's important to do these COGS calculations for each product so you can price it accordingly. If you're producing products in batches, then divide the cost of producing the entire batch by the number of items in the batch to determine the average "unit cost" of making just one.
If you provide services rather than (or in addition to) selling physical items, there's a cost to providing that service. You need to put a figure on this in order to accurately set your prices.
Remember, it's not just about any consumables you might use while actually providing the service — such as shampoo if you run a dog washing service or internet service and software if you’re a graphic designer. You also need to think about the value of your pre- and post-sale effort, along with your skill, recognition and experience. This can be tough to value, but it’s worth the effort.
Shop around to see what others with your skills and experience charge to get a sense of what the market will bear.
Even if providing a certain product or service seems easy to you, the goal is to charge what it's worth to others. Remember, they're paying for your expertise, which you've perhaps honed over years, so don't undersell yourself. You might also be able to charge a premium based on your experience, expertise and certifications.
Pro tip: Should you do work on spec (aka for free) in the hopes of getting paid? As a general rule, no. While new entrants to a field might price themselves at the bottom and work their way up as they gain clients and recognition, there’s no benefit to working on spec.
2. Calculate your overheads
This is where you include all the other costs that you incur as part of running your business.
Your overheads might include:
- Rent for factory or office space
- Special equipment (e.g. computers, printing press, etc)
- Utility bills
Then comes all the other expenses incurred in delivering your product or service, from pre-sales support and customer service to boxing, shipping, marketing and even things like insurance.
Fixed vs. variable costs
When it comes to costs and overheads, keep in mind that some will be fixed and others will vary, especially if you're at the mercy of international exchange rates or fluctuating prices for raw materials. So you might need to add a margin to act as a buffer if costs rise.
Once you have a total amount for your annual overheads, you can then determine an "overhead percentage" to factor into your price. So if your gross annual sales are $100,000 and your annual overheads are $10,000 then your overhead percentage is 10%. This is another thing that needs to be added to the price of your products or services.
3. Finally, set your markup rate
Once you've listed all your expenses, then you need to determine your markup rate.
The markup is the amount that's left for you after you've covered all your costs and overheads.
Your rate could be a fixed amount or a percentage of the overall price.
Now multiply your costs of goods sold by your overhead rate to determine your "cost price." Then you add your markup rate as a percentage.
- So if you sell jewellery and a specific necklace costs $50 to make, and your overhead rate is 10%, then you multiply $50 by 1.1 to get a $55 cost price for that necklace.
- If your markup rate is 50%, then you multiply the $55 cost price by 1.5 to get a $82.50 final price for that necklace.
You can find a markup calculator here. Remember, depending on your business, you might also need to charge 10% GST and tack that onto the final price.
An example of how to set prices for services
It's a similar story if you're selling services. If it costs you $5 in consumables for a standard dog wash, and your overhead rate is 20%, then you multiply $5 by 1.2 to get a $6 cost price for a standard dog wash.
If your markup rate is 300%, then you multiply the $6 cost price by 3 to get an $18 final price for that standard dog wash (perhaps plus GST).
Finding your sweet spot
While charging less than the average can bring customers in the door, it can also hurt you because you don't want to come across as cheap. Setting a higher price for a luxury product or service, can create the sense of a premium offering that is worth the extra expense.
Of course there's also the temptation to go too high and risk pricing yourself out of the market.
When determining the right price, it's important to consider how rare, scarce, essential, well-known and compelling your customers will find your product or service. The higher your offerings rate in these categories, the more people will be prepared to pay.
Fiddle with the equation
If the final price you've calculated seems a lot higher than what people are prepared to pay, then think about how you can change the equation.
- Is your rate realistic?
- Are you targeting the wrong customers?
- Are there ways to lower your Costs of Good Sold and overheads, or ways to increase your productivity, to lower your end price?
- Are there changes you can make that would allow you to justify increasing the price, such as improving the quality, without having too great an impact on your costs?
Understanding the true costs of providing your products and services can help you determine which are the most profitable — and no, it's not always the ones you charge the most for. This kind of insight can help you focus your efforts; it might even be the pivot point where you decide to change the direction of your business.
When planning your mix and pricing of products and services, also consider the limitations of your production capacity and time. Don't assume that halving your price will allow you to sell twice as many.
For starters, it might not be feasible to double your production runs or work twice as many hours. Even if you can, is the demand there? If not, are you missing a gap in the market? This is where some market research can really pay off.
The long and short of setting prices for products
There's more to setting your prices for products and services than simply plucking a number out of the air.
In fact, whatever you do, don’t pluck a price out of the air.
It's important to understand your costs, allow for your overheads and then factor in your markup rate to ensure that you're not selling yourself short. While under- or over-pricing your products might not hurt you in the short run, it could cost you down the track. Be smart and do a little research first.;