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YOUR PRICE
Cost,
Competition, Customer
Establishing prices involves three primary
considerations. These are as follows:
* Your cost
* Your competition
* Your customer
Minimum Price
In normal circumstances, cost can be considered a minimum price. Certainly,
when closing out a product line or reducing a surplus in inventory, you may
temporarily sell below cost. But pricing below cost can never be a continuing
formula for prosperity. Nor can selling at your cost be expected to make you
prosperous.
Competitive Prices
If you cannot sell below cost, then how far above
cost can you sell? This will be influenced by your competition. Perhaps your
product has certain advantages that justify a higher price. Perhaps you plan
to sell below competition to capture the largest possible share of the
markets. But there is a delicate balance involved in selling below
competition. Will the increased number of units sold result in enough
additional profit to warrant cutting prices? And, will a lower price give
your products an unfavorable image?
Customer Reaction
How will your customers react to prices higher than
competition? Will they recognize the advantages of your product and pay the
premium? Can they be persuaded by salespeople that your product is worth a
little more?
On the other hand, your product may be no better than that offered by
competition. Nor can you point to any significant advantages in the product
support that you offer such as service, delivery, or credit terms. How large
a discount will be necessary to attract customers away from your competition?
How much will it cost to tell the market that you sell for less?
Establishing a Price Floor
The first step in pricing is to determine your product cost, the floor below
which prices cannot fall.
All costs can be classified as variable or fixed (overhead). Variable costs are the
out-of-pocket costs or costs of doing business that you incur with each unit
of your product that you sell. They include the purchase price of goods
acquired for resale, sales commissions, and any product preparation charges
such as alterations or delivery costs.
Fixed costs are the costs of being in business. These costs include such
items as rent, administrative salaries, equipment depreciation, and office
expenses. They go on from month to month with little variation due to sales.
Consider a product that sells for $1.00. You buy it for $0.50, pay a $0.06
commission on every sale, and incur delivery costs of $0.04 on every sale.
Each time you sell one unit you realize $1.00 in revenue and incur $0.60
($0.50 + $0.06 + $0.04) in out-of-pocket costs.
Each $1.00 sale provides $0.60 to pay your variable costs. The balance of
$0.40 ($1.00 - $0.60) contributes to covering your overhead and, once your
overhead is covered, producing a profit.
Unit Contribution
The difference between the selling price and the variable cost can be called
the unit contribution.
Unit Selling Price
- Unit Variable Cost
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