When you’re selling products, the price of your product will play a major role in determining whether or not your product succeeds on the market. However, there are several factors that go into deciding how much to charge for your product, and it’s important to understand them all in order to come up with the most profitable price possible for your business. Below, we’ll cover five major factors that influence the cost of your product and give you some advice on how to avoid costly mistakes during each phase of production and pricing.
1. Raw material costs:
Raw materials are always going to be a factor in determining price. If you use higher-quality raw materials, you can expect to pay more for them, and higher costs mean higher prices for customers. One thing to keep in mind is that different industries have very different standards for what counts as high-quality; price is often just a signal of quality, and so you’ll have to make sure your standards match those in other fields.
If you can find a way to reduce your raw material costs, you’ll also reduce how much it costs to produce each unit. This is usually one of the first places companies look for savings, so if you can do it well, you’ll have an advantage over other firms.
Use materials with high recycled content to reduce waste and other costs. For example, choosing plastic packaging over glass or aluminum means lower costs for you and a less negative impact on the environment as well.
If you’re looking to reduce costs, consider having some materials delivered in bulk. Rather than ordering them one-at-time as needed, work with a supplier to order larger quantities that you can store until they’re needed. In many cases, you can get discounts for buying in bulk, so it can mean both lower costs and better profits.
If you’re trying to reduce raw material costs, it may be helpful to consider new materials. A firm with a unique material might not have competition, and it could set their price as high as they want. This can be a difficult strategy because consumers are wary of purchasing unfamiliar goods, but if you have a strong brand or marketing team, it can be very effective.
2. Scrap costs:
If you are thinking about launching a new product, it’s important to start by making sure you can produce it. Don’t just rely on prototyping to tell you if a new item is feasible — talk to suppliers and manufacturers to determine how much raw material costs, how much labor will be required, and how many items they can produce at once. Each of these details has an impact on final price point.
Raw material costs are especially important if you are planning to make your new item from scratch. It is a common misconception that new products need to be made from recycled materials, or alternatively, by-products of other industries. This isn’t necessarily true! Be sure to take raw material costs into account in order to determine how much you can profit on each item.
Every item has a minimum number of units that it needs to sell in order to break even. If you make more items than that, you’ll start making profit. But if sales are low or prices are high, you won’t see a return on investment. Make sure your price is appealing and competitive so customers will pay for it!
Along with production costs, there are also transportation costs to consider. Shipping costs can vary based on size and weight, but it’s a good idea to factor in a 10% increase as a buffer. Transportation is an important part of supply chain management. Every new item you launch will have to be shipped from your warehouse to retailers or directly to customers in some cases. Make sure you have enough budget for shipping!
To determine how much to charge for your new item, you need to think about what consumers are willing to pay. What is a reasonable amount for them to spend on something like yours? It’s important to pick a price that won’t turn away potential customers while also accounting for production costs and transportation.
Once you’ve factored in scrap costs, raw material costs, transportation costs, and pricing strategy, you should have a good idea of how much to charge for your new item.
But one thing is still missing: profit!
It’s important to plan out profit margin as well before launching a new item. By multiplying your price by 1.25 (1.2), you can get an idea of what kind of markup percentage works for consumers.
Also, consider when you are planning to launch a new item. Selling something for $100 in November is going to be a lot harder than selling it for $100 in January!
Sales tend to rise as we approach holidays and peak during holiday season, so it’s important to make sure you are confident with how much money you can make. When choosing when to launch, look at sales trends from previous years and compare them against demand for similar items from other companies.
3. Set up cost:
The money you spend on purchasing or creating a business is called its set-up costs. Examples include things like buying new office equipment, constructing a store front, developing a website and more. Many people underestimate these expenses — for instance, depending on what you’re selling, construction costs could run into thousands or even millions of dollars if you’re opening up a restaurant or retail space.
Shipping costs can vary significantly depending on where you’re shipping to and what kind of delivery method you choose. A small, lightweight product may cost $3 to ship in a padded envelope, while a bulky one could come with a much higher price tag. The same principle applies when deciding how fast you want your products delivered — and at what cost.
Buying stock is another major up-front cost to consider. If you’re planning on keeping a large inventory, you’ll need to set aside a budget for purchasing those products — even if they aren’t selling yet.
And finally, there are ongoing costs, which you’ll need to factor into your budget. They include things like paying employees, maintaining equipment and buying inventory. Consider what type of business you’re opening — you may have significant set-up costs if you plan on opening a brick-and-mortar store, for example.
Keep in mind that even if these expenses come out of your own pocket initially, they will likely be added to your final price tags.
This is important because it gives you an idea of how much money you’ll need to get started, and whether or not it’s something you can afford. It also helps you determine what price points to set — if a set-up costs $5,000, but profit margins are 25%, then a price point of $10 per item is probably fine. However, if profit margins are only 10%, a higher price point may be needed to make up for those costs.
These are just a few examples — but it should give you an idea of how set-up costs can quickly add up and affect your pricing. Think about all of these factors before deciding on a final price point for your products or services.
Make sure you consider every step in between when starting a business, from construction to shipping and more. With these considerations in mind, you’ll be able to determine how much your products will cost — and if you can make money selling them.
4. Variable overhead costs:
In some industries, especially in construction, producers can’t know what each unit will cost until they actually produce it. For example, with a large project like a house or shopping mall, you can’t estimate costs beforehand because you don’t know how much cement or lumber you’ll need.
Also, you don’t know how many workers will be needed to complete certain phases of production; so if a worker gets sick and has to be replaced, costs will increase unexpectedly. These are all variable overhead costs.
Variable overhead costs increase as production increases. It’s often impossible to estimate how much these costs will be. So, if more units are produced than estimated, variable overhead costs will increase proportionately.
The same is true for less production — costs fall when expected production is lower than what actually occurred. But, since you can’t estimate beforehand how many units will be produced, it’s impossible to know in advance exactly what these costs will be.
Variable overhead costs are often incurred when production begins, not when products are sold. So it may be possible to increase production and lower per-unit costs. For example, increasing productivity through automation may lower labor costs and offset increases in other variable overhead costs.
Variable overhead costs can be reduced by increasing production and sales. At some point, though, increases in production lower per-unit variable overhead costs; so companies must figure out what is an efficient level of production at which to operate. A company could lose money if it produced below or above its efficient level.
Variable overhead costs are very different from fixed overhead costs. Fixed overhead costs remain unchanged, no matter how much production occurs, whereas variable overhead costs increase as more is produced.
5. Fixed overhead costs:
Fixed costs, like rent and utility bills, don’t vary depending on how much you produce or sell. When you calculate your variable and fixed costs, account for everything you expect to spend — plus an additional 10 to 15 percent. This ensures you can provide enough inventory to meet expected demand and make a profit.
You also need to factor in costs associated with hiring employees, buying equipment and maintaining proper insurance. Employee costs can be substantial, particularly if you hire full-time staff.
Use resources like Payscale to determine an appropriate salary for roles you’re considering filling. Many business owners choose part-time employees who work from home rather than full-time positions because it saves on overhead costs like office space, equipment and other operating expenses.
A large capital investment — such as an office and equipment — could be a fixed overhead cost. However, if you’re starting a business from home, it may be considered a variable overhead cost, as its value will change based on how much time you spend working from home versus in an outside location.
Advertising can also be an overhead cost, but only if you plan to hire someone to manage paid marketing efforts. If you’re handling advertising in-house, it will likely be considered a variable cost.
Overhead costs can have a substantial impact on pricing, so it’s important to factor them into your business model.
Let’s walk through an example: Say you’re selling running shoes for $110 and use a variable overhead costing approach. You expect to spend $100 on direct material costs and $7 on overhead costs. Your total overhead is $107.
Because you don’t want to offer a price that’s too low, you take 10 percent off your total overhead: $107 – $10 = $97. That leaves you with a price of $97 x 100 = $9,700. So if you want to sell 1,000 pairs of shoes at $9.70 each, it will cost you about $9,700 for materials and overhead costs.
Then you need to figure out how much you want to make on each pair. For example, say you want to earn a profit margin of $40 per pair. Your price would be $40 / 100 = $4 per pair. That means it costs you $9,700 x 4 = $43,600 to produce 1,000 pairs — or about $43,500 in gross revenue.
If you only sell 600 pairs and make $34,200 in revenue, it means you’re losing money on each pair. That’s because you need to earn at least $40 per pair ($4 x 100 = $400) before accounting for overhead costs. If selling more pairs doesn’t increase your gross profit, reduce overhead costs or find a new supplier for materials.
Now let’s look at what happens if you set a price based on variable overhead costs. Let’s say you expect to spend $7 on direct material costs and $3 on variable overhead costs, for a total of $10 per pair. You can calculate variable overhead costs by dividing your total estimated variable operating expenses by your expected volume.
To do so, you’ll need to estimate how many shoes you plan to sell. For example, if you think you can sell 1,000 pairs of shoes, divide $10 by 1,000 = $10/pair. If it costs you $3 for every pair sold, your variable overhead costs are $7 / 1,000 = $0.07/pair x 1000 = 70 cents per pair.
Next, you need to estimate how much it will cost to make a pair of shoes. The materials account for $7 / 1,000 = $0.07/pair x 1000 = 70 cents per pair, so variable overhead costs + materials is $10.07/pair + $7/1,000 = $10.08/pair. That means you can sell a pair for up to $10.08 and still generate a 10 percent profit margin on every sale.
To figure out how much you should charge for a pair, you need to add another 10 percent to your $10.08/pair price: $10.08 + $0.10 = $10.18/pair x 1000 = $101,800.
If you sell every pair at $10.18/pair, you’ll have a profit margin of 10 percent: $101,800 – $10.18 x 1000 = $92,630.
However, if you sell 1,000 pairs and earn $92,630 in revenue (i.e., a 10 percent profit margin), you won’t have enough money to pay for overhead costs or materials. Fixed overhead costs + variable overhead costs = $10.18/pair x 1000 = $11,180 + $7/1,000 = $0.07/pair x 1000 = 70 cents per pair = $11,250.
If you want to make sure you have an attractive price for your business, it’s important to look at all five of these factors and do what you can in each area. If you are using top-quality materials, making a high-end product, and conducting market research, then you should be able to get away with charging a higher price for your final piece.
But what if you want to ensure you aren’t undercharging for your items? In that case, consider making sacrifices in a different area. If you can lower how much time and effort goes into each piece by using less expensive materials or outsourcing some of your production, then it will allow you to charge a lower price.
Sometimes price is determined by what customers are willing to pay, so it’s important to do some research and find out what other businesses in your area are charging for similar products. If you charge more than they do but offer comparable quality, you might find yourself losing business. But if they charge more than you do and don’t offer a high level of quality, then you can undercut them on price while still earning a profit.
When you’re trying to figure out how much to charge for a product, always look at all five areas and make sure you have a balanced approach. This will help ensure you aren’t undercharging or overcharging and help you find pricing strategies that work best for both your business and customers.
- Looking to boost your product sales? Check out these top tips!
- 5 Myths about online advertising you need to stop believing
- 3 Steps to starting an online business from scratch
- 10 Ways to earn money online without investing a dime