Q. How do we price our product? We buy some products in bulk (sometimes as much as 200 kilograms), weigh it out into much smaller quantities (sometimes as little as 50 grams), package and label it and sell it. We know how much the products cost us per gram, and the cost of the packaging etc, but is there a magic formula to build in the time and overheads etc, and so come up with the lowest price we should be selling the items for?
A. This is a very common question often raised by business owners entering new markets. Having the lowest price may not necessarily be the best option for you. The answer to this question is in two parts:
1. Calculate your break-even price
I do not believe there is any magic formula in establishing what your lowest price could be, other than an essential understanding of what your break-even position is. Calculate all of your raw material and manufacturing costs, including an allocation for labour and other business overheads such as rent, electricity etc.
You could total all of your business overhead costs and divide this by the total number of kilograms of product sold, thereby coming up with an average overhead cost. This will at least tell you that if you sold your product below this price you would be losing money.
The first step is to calculate your break-even price. That is, the amount of money your product can be sold for to cover the costs of acquiring and labouring it. For example, let’s say you package and sell 1000kg of various cheese products a week. Your cost of goods sold is $4kg and sale price is $8kg with a 50 per cent gross profit. Selling 1000kg of cheese at $8kg gives you $8000. Then take off $4000 ($4kg x 1000) as your cost of goods sold and that gives you a $4,000 gross profit.
Your overheads are as follows (calculated per week):
- Electricity - $50
- Rent -$300
- Labour - $500
- Admin/marketing - $300
- Total - $1150
- Net Profit - $2850
How much cheese do we need to sell per week at the current sale price to break even? Answer 288kgs
- Sales of 288Kg of cheese at $8kg - $2304
- Cost of Goods sold at $4kg - $1152
- Gross Profit - $1152
- Overheads as above - $1150
- Net Profit - $2
Assuming we sell 1000kg of cheese per week, at what sale price per kg do we break even? Answer $5.15
- Sales of 1000kg of cheese at $5.15kg - $5150
- Cost of Goods sold at $4kg - $4000
- Gross Profit - $1150
- Overheads as above - $1150
- Net Profit - $0
Now that the break-even point is determined, you can then charge a margin on top based on your research and market knowledge which will be your retail price.
2. Understand what the market is prepared to pay and set your price accordingly
Before launching any new product lines, ensure you do your research. It will help you determine what your customers want, how much they would be prepared to pay and how they will respond to your offer. Setting the price of your product therefore has more to do with market perceptions than your costs. A good example of this in our day-to-day lives is that the cost of bottled mineral water is more expensive than the cost of milk or petrol per litre. This demonstrates that the market price is not necessarily tied to your costs, and that it's important to do you research on the market before setting your prices.
Marketing and Business Manager, Small Biz Connect (Sydney north-west region)