Since the inception of businesses, this question has perplexed most owners: How should I be pricing my product or service? This query has existed long before AI, the internet, and even electricity.
An article in the NZ Herald from June 2024, titled “Big Red: What Went Wrong for The Warehouse,” highlighted the struggles of one of New Zealand’s most famous retail brands, The Warehouse. A senior analyst at Forsyth Barr posed the question, “I don’t know if they [The Warehouse] know what they are and how they fit into the New Zealand retail landscape, or what they are going to compete on.” Greg Smith of Devon Funds Management added, “They need to recalibrate what is the value proposition.” The Warehouse, which has traditionally relied on bargain prices as its core attraction, now faces competitors like Kmart redefining what constitutes a bargain for its customers.
Despite The Warehouse being a large, complex business in a highly competitive market, its challenges are relevant to SMEs. Regardless of business size, the principles of success remain the same. Understanding who you are selling to, why they should buy from you, and how much they are willing to pay are foundational to the success of both global conglomerates and small enterprises.
We’ve all heard stories about retail employees who misunderstood instructions about pricing clearance items, accidentally doubled the price, and sold out in a day. Pricing affects everything from your business finances to your product’s market positioning, considering whether it’s timeless, bespoke, or a fleeting trend. It’s a key strategic decision that combines both art and science.
This decision is ongoing and not a one-time event.
For example, when setting the retail price of a product, there is a quick and straightforward method to establish a starting point.
To set your initial price, add up all costs involved in bringing your product to market, then add your desired profit margin on top of those expenses. This method, known as cost-plus pricing, is one of the simplest ways to price your product.
Another approach is to gain insights from your existing customers to determine if you can raise your prices. Start by testing a higher price with a small segment of your current customers and observe their reactions. However, before finalising your product’s selling price, consider several important factors.
An effective pricing strategy starts with understanding your costs. If you purchase products, you can easily determine the cost per unit, which is your cost of goods sold (COGS).
If you manufacture your products, a more detailed analysis is required. Look at a bundle of your raw materials, labour costs, and overhead expenses. Determine the cost of this bundle and calculate how many products you can produce from it. This will give you a rough estimate of your COGS per item. Additionally, don’t forget to account for the value of your time spent on the business.
To price your time, set an hourly rate you wish to earn, and then divide that by the number of products you can produce in that time. To ensure a sustainable price, include the cost of your time as a variable product cost.
Ultimately, your price should be one that your target customers are willing to pay consistently.
Here’s a simple calculation to verify your pricing strategy. Once ready to set a price, take your total variable costs and divide them by 1 minus your desired profit margin expressed as a decimal. For example, for a 20% profit margin, divide your variable costs by 0.8.
Remember, variable costs are not your only costs.
Fixed costs are expenses you incur regardless of sales volume, remaining constant whether you sell 10 products or 1,000. These costs are crucial to running your business, and the goal is to cover them through product sales. When setting a per-unit price, it can be challenging to incorporate fixed costs, making it essential to test different price points.
Of course, there are many variables and nuances to consider, but the goal is to not get initially overwhelmed. Set a pricing benchmark to provide a “compass bearing” on whether you are heading in the right direction.
Therefore, if you struggle to answer this questions or want to step back to reflect, it’s a beneficial exercise. If a publicly listed company like The Warehouse struggles with this question, you are not alone. See this as an opportunity to ensure your business covers the fundamentals of success.