Accurately pricing products is one key to earning a profit
Setting price too low or too high will prevent maximum earning potential.
February 9, 2012 - Author: Mary Robb, Michigan State University Extension
Taking the time to put together an accurate picture of the costs of the production and distribution of a product will provide an entrepreneur with a sound basis for a profitable business.
Entrepreneurs are usually high-energy “doers.” If, in their enthusiasm to get the product to market, they fail to look at all of their costs, they might price their product either too low or too high. The result in both cases may be that the business fails to earn a profit. Realistic pricing covers the costs, earns a profit, and attracts customers. Once a product is introduced into the market, it may be difficult to adjust the price without creating a negative reaction from customers.
There are three specific factors to be taken into account when determining the costs associated with the productions of a product. First, consider the direct costs, including all the materials and supplies needed to produce the product. In a food product, this would include the ingredients, the container and the label. Some might also include other fixed costs here such as the difference between wholesale and retail and the percentages paid to independent distributors when they are used.
In the beginning, cost of labor is often ignored and is usually considered an “in kind” contribution from the business owner. As the business grows, this will have to change. Wages that will eventually need to be paid out to produce the product should be included in the calculation now rather than trying to change it later on when demand increases.
All of the other costs of running a business that are not directly related to the actual production of a product are considered to be overhead expenses. These include things such as: advertising and marketing, taxes, office supplies, insurance, rent, equipment, distribution costs if you are delivering the product yourself, and any other business-related costs you expect to incur as the product is brought to market.
Once an entrepreneur has a good handle on the costs of production, some research needs to be done to determine whether this is a product that can earn a profit. Putting together a competitor log is a good way to shop for similar products and compare prices. While price is not the only factor that influences consumer buying habits, it is a good place to start.
A successful entrepreneur keeps complete records on costs and uses this information along with good market research to set a reasonable price that will cover the costs, earn a profit and attract customers.