The most common way to determine your selling prices is usually the cost plus strategy. You calculate exactly what a product costs and add your profit to it, which results in your average selling price. The only shortfall with this method is that if you don’t include all your costs, the net profit is really lower than you think it is. Sometimes it’s a good idea to add a few extra percentage points to the cost for unexpected expenses or things you’ve forgotten. When considering your total cost per product, here are some factors to consider:
- Manufacturing or supplier costs
- Packaging or repackaging costs
- Staff selling expenses
- Advertising, direct mail, and promotion costs
- Administrative staff expenses
- Maintenance and repairs
- Rent and office expenses
- Shipping and receiving costs
- Costs for physical selling aids and displays
- Distribution costs
- Collection and loan interest costs
- Bad-debt losses and collection costs
- Return and exchange expenses
- Interest on borrowed capital
Add all these costs together and divide the result by the number of actual products or units to get your approximate cost per unit or package. Now you can add to your cost the percentage profit you need or want to make. It’s a good idea to stay within the range for your industry so that you will be competitive. You should review what your competitors’ prices are and decide whether you want to be higher, lower, or about the same. If you’re selling to other businesses, you’ll need to have a comfort zone where you can offer quantity discounts, which is generally expected for large orders.
Another pricing strategy is to determine your selling price first and work backward to your cost. This method is generally used if you want to meet or beat your competition or establish a high-quality, new product in the market.
If your prices are low, you need to find ways to reduce or control your supplier or manufacturing costs. Look for and evaluate new suppliers that can offer similar products at a lower cost or better quantity discounts. If you need to sell at a specific price point and you just can’t get your manufacturing costs any lower, you might want to consider outsourcing production to a separate company. Once you find a manufacturing company with the correct equipment and cost, you can also eliminate some of your payroll and benefits expenses, as you’ll be trimming your workforce. The manufacturer
can sell to you, a dealer, for less because they have little or no advertising, sales, and promotion expenses.
The bottom line is that if your selling price is predetermined, you must get your cost to a point where you will make a profit.
A longtime friend in the Chicago area built his entire business by selling at prices the buyer couldn’t resist. He was a distributor of loose gun nails, automatic staples, and construction supplies for use in home building and manufacturing. He studied his market, found what customers were paying, and offered a lower price for a larger minimum order. Unlike other suppliers, who cut services when they cut prices, he didn’t. He offered free delivery to construction sites early in the morning, which no one was doing—especially very early in the morning. He also supplied the automatic “guns” for
nails and staples free of charge for those buying his products. He included prompt repairs or replacement gun machines when breakdowns occurred. It was difficult for his customers to change suppliers because they would have to return all the free equipment.
To sell at the lower prices, he called every manufacturer in the U.S. and some around the world and attempted to get the best prices if he guaranteed a certain quantity of purchases and quick payment. He’s currently buying a majority of his nails from Far East and European countries and finds the quality is excellent. Because his orders are for big container loads, he gets the suppliers’ very best prices.
In the beginning, he used his home equity to finance these larger purchases, and later banks gave him substantial lines of credit. Today, his business is going strong with about $18 million in sales, and he is still using the same pricing strategy. He has added a few additional products with higher margins that many of his customers purchase without comparison. I have always admired his ability to judge his target market.