If you’re already running a business, planning to start one, or you work in a department of a larger company that is responsible for its own sales, you will realise that setting the right price for your products can be difficult. It involves many factors, including taking into consideration what your competitors are charging for similar products.
In the ideal situation, companies want to charge as much as they can for their products to generate sales and, ultimately, profits. That is the whole reason for being in business in the first place!
Economists know that there is an optimum price, a price that generates the most sales revenue. If the price is marginally above this, your product may still sell, but not in quite the same quantities, thus reducing profits. Drop the price too much and you may see sales rise, but lose out on further profit because you’re selling your goods too cheaply.
Price is also a psychological battle with the consumer. It’s possible that a price can be perceived by the customer as being ‘too cheap’. Then the customer starts asking questions. What’s wrong with it? What do the competitor’s products do better if I spend a little more? But, on the other hand, you don’t want it to be so expensive that everyone goes to your competitors!
The prime concern for companies is that the price needs to cover the cost of the product and a bit more, if they want to make a profit. Price a product below the cost of production and the company won’t be in business for very long.
For most businesses, setting prices is about covering their costs and then charging what they think consumers or other businesses will be willing to pay. Some companies use the simple cost-plus or mark-up on cost pricing system, and this is how most people assume prices are set.
To calculate the price of a product, you simply take its unit cost (how much it cost to make) and then add on a percentage for profit. If the unit cost of a roll of sticky tape was £1.61, then you might set the price at £2.75. For every roll sold at £2.75, in theory, you’d be making a profit of £1.14. This system is acceptable if you know that your costs won’t change and that you will sell every roll of sticky tape that you make.
However, there are better – and more accurate – ways of pricing up your products. But, they do take longer to explain than the cost-plus method. So, if you are interested in finding out more about this subject and making sure that your company is getting the right balance in its pricing policy then you should have a look at our Finance for Non-financial Managers Course. You’ll end up knowing not just more about pricing but all the other essential financial aspects that are essential to operate a successful business.
Author: Diana Nadin
