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The Sweet Spot of Pricing

Pricing your product is an art — and a little bit of science.

The most important concern of a business is finding that pricing sweet spot that ensures excellent profits and willing buyers. This is not so easy to figure out at first, but the market will tell you whether or not you are in that good place.

For example: I owned a house that was appraised by the bank at $550,000. The bank. Who would know better, right? Since I paid $240,000 for it a few years earlier, I assumed I had equity of $310,000. When I sold it, buyers were not flocking to my door. It sold for $375,000. THAT was what the product was worth, not the amount the bank assigned it.

The actual value was what the buyer was willing to pay. The buyer knew better than the bank, to my dismay. This was an important lesson for me!

What factors matter when you price a product for sale?

As a business owner, you must find that sweet spot and not worry about anything else — like greed or the psychology of the buyer. Simple question: will they buy more at this Price A or Price B? Can I be profitable at price A? That is ALL you need to figure out. Easy.

But, Seller Beware!

  • In your pricing considerations, you may compare yourself with competitors. Do not let that lead you to over or under-confidence. You must pay mind to your product and its value to your customer. That is the only consideration that matters. The buyer will accurately calculate the value of your product. If you have consistent sales, you have found the SWEET PRICING SPOT.
  • Do not fall into the complacent merchant mode. If you are selling well, you may think that raising your price will enhance your profits – and it will, if and only if, you maintain the level of sales you have grown to love.
  • Raising your price may make your customers rethink the attractiveness of your product. They may stop buying and you may fail to attract new customers at the revised price point. Be sure to verify that a price increase will enhance your sales, your profitability and your business —before you take drastic action. Do the appropriate research before you alter a successful pricing structure.

How to price your product in three easy steps

There are three major practical considerations to take into account when determining your price point. Like so:

  1. Add up your variable costs (per product)
  2. Add a profit margin
  3. Don’t forget about fixed costs

1. Add up your variable costs (per product)

First and foremost, you need to understand all of the costs involved in getting each product out the door.

If you order your products, you’ll have a straightforward answer as to how much each unit costs you, which is your cost of goods sold.

If you make your products, you’ll need to dig a bit deeper and look at a bundle of your raw materials. How much does that bundle cost, and how many products can you create from it? That will give you a rough estimate of your cost of goods sold per item.

However, you shouldn’t forget the time you spend on your business is valuable, too. To price your time, set an hourly rate you want to earn from your business, and then divide that by how many products you can make in that time. To set a sustainable price, make sure to incorporate the cost of your time as a variable product cost.

Sweet.

Here’s a sample list of costs you might incur on each product.

  • Cost of goods sold: $3.25
  • Production time: $2.00
  • Packaging: $1.78
  • Promotional materials: $0.75
  • Shipping: $4.50
  • Misc. costs: $2.00
  • Cost of goods sold: $3.25
  • Production time: $2.00
  • Packaging: $1.78
  • Promotional materials: $0.75
  • Shipping: $4.50
  • Misc. costs: $2.00

Total per-product cost: $14.28

2. Add a profit margin

Once you’ve got a total number for your variable costs per product sold, it’s time to build profit into your price. Yay.

Let’s say you want to earn a 20% profit margin on your products on top of your variable costs which we determined is $14.28. When you’re choosing this 20 % for profit, it’s important to remember two things:

  1. You haven’t included your fixed costs yet, so you will have costs to cover beyond just your variable costs.
  2. You need to consider the overall market, and make sure that your price with this margin still falls within the overall “acceptable” price for your market. If you’re way more than price of all of your competitors, you might find sales become challenging, depending on your product category.

Once you’re ready to calculate a price, take your total variable costs ($14.28), and divide them by 1 minus your desired profit margin (0.8), expressed as a decimal. For a 20% profit margin, that’s 0.2, so you’d divide your variable costs by 0.8. Like this: $14.28 ÷0.8=$17.85. Round up to $18.00. This is your variable price per unit.

So now, take your Target Price formula = (Variable cost per product) and divide by (1 – your desired profit margin as a decimal). It will look like this: $18.00 ÷ 0.8 = $22.50

Okay, so we need to charge $22.50 (so far), right?

Is that sweet spot price? Not yet.

3. Don’t forget about FIXED COSTS

It’s important to remember that variable costs aren’t your only costs. Fixed costs are the expenses that you’d pay no matter what, and that stay the same whether you sell 10 products or 1000 products. They’re an important part of running your business, and the goal is that they’re covered by your product sales as well.

When you’re picking a per-unit price, it can be tricky to figure out how your fixed costs fit in. A simple way to approach this is to take the information about variable costs you’ve already gathered, and set them up in this break-even calculator spreadsheet.

Sweeter yet

Fixed monthly costs (example)

  • Computer Hardware: $100
  • Software; $200
  • Insurance: $100
  • TOTAL: $400

Look at your fixed costs and your variable costs in one place, and to see how many units you’d need to sell of a single product to break even at your chosen price.

  • Variable Cost: $14.28 + Fixed Cost $500= $514.28 per unit
  • Product price per unit (at a 20%) markup=$22.50

If I sell 100 units @$22.50 each, my gross sales are $2250. Minus variable cost ($18×100):$1800 and fixed cost: $400 = PROFIT: $150.

If I sell 150 units @$22.50, my gross sales are $3375. Minus variable costs ($18 x150): $2700 and fixed cost $400= PROFIT: $275

If I sell 500 units @$22.50, my gross sales are $11250. Minus variable costs ($18 x500): $9000 and fixed cost $400= PROFIT: $1850. Okay, now we are talking.

These calculations can help you make an informed decision about the balance between covering your fixed costs and setting a manageable and competitive price. Obviously changing any of the variables will impact your price.

You definitely want to find out everything you need to know about performing a break-even analysis, including what to watch out for and how to interpret and adjust based on your numbers.

It only becomes the SWEET SPOT when the net profit exceed the total cost of goods. And when the market says, “YES! I Will PAY THAT PRICE!”

Now THAT is a SWEET SPOT

In summary

To sing all the way to bank, you must have the right product at the right price to market to the right customer base: the oh-so SWEET SPOT. Ultimately the market will be sure to determine the right price. Hopefully, it matches your profit goals and then you have a business!