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How to Price Your Product – Part 2
Cost Pricing
Many inventors have a hard time pricing their product. Why is this? It is because pricing your product is a very difficult task—one that takes weighing multiple factors. The two main aspects you need to weigh are cost and market factors. We will deal with pricing in a three part series, with the first part dealing with market pricing, the second part dealing with cost pricing and then the third part dealing with how to balance the two.
Cost pricing refers to setting your price based on your product and distribution costs. These costs will be different for the same product in different distribution channels.
There are many costs that are involved in running a business. You have administrative costs, marketing costs, space costs, taxes, insurance, product development, employee benefits, incidental expenses, travel expenses, and the list goes on. So when you sell your product, your price needs to be enough to cover all of these expenses.
The standard cost pricing formula is simple: retail price is four times the manufacturing costs. The manufacturing costs include labor, parts, distribution, packaging and overhead costs for manufacturing and administration. Doubling your manufacturing costs would typically give you your wholesale price if you were selling to distributors or retailers. This may seem high, but many companies make a total profit of only a few percentage points, so it is not too high at all.
So where does the rest of the money go? It goes into those expenses mentioned above: product development, insurance, etc. This is why financial personnel in many companies are so important – if your company only makes a profit by a few percentage points, an adjustment in costs, either higher or lower, can mean your company will not make a profit or will be increasing their profits considerably.
So is pricing your product just as simple as four times your manufacturing costs? Maybe, but you should consider all of your costs before you set your price.
Is there something about your business that creates higher costs? For instance, in technological companies, the cost of developing new products is very high. If you are planning on developing new products, which you should do, you will need to charge more for your current product to cover the costs of developing new products. Or if you have a product that needs a lot of insurance, again you will need to charge more for your product to ensure you can make money.
Another factor in pricing your product is your distribution. If you sell directly to retailers, your wholesale cost will be half of the retail cost, so your retail price will be four times manufacturing costs. If you have more complicated sales, like through sales agents or representatives, who then sell to distributors, there are more people who get paid, so your retail price will need to be higher. Different industries have different standards of distribution. Some always sell through distributors, others not. You will need to look into how many people your product will need to go through before the product finally reaches the consumer. Each group has a certain mark up, usually expressed as a percentage of the price. Once you have your manufacturing price, double it for yourself (or more as discussed above) and then count the costs of the distribution mark ups and then the retailer will sell the product for twice what they pay for it, so add another 100%, and this will be your retail price.
If you sell directly to consumers, your retail or final price can be much lower, but again, you can’t set your price too low, because there are many costs involved in selling directly to customers. For instance, if you manufacture your product yourself, possibly in your garage, and sell the product on the internet, you might think that everything you charge over the cost of parts in money in your pocket. This will not be true. You will have product insurance costs, website costs, marketing costs (which will probably be higher than you expect), office supplies, telephone bills, etc. But because of the lack of distributors and retail discounts, you can probably make a profit if you sell your product for twice the manufacturing price, which would include paying yourself for labor and overhead costs. This is why products sold directly to consumers can be cheaper than in retail stores.
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