Having gained a full understanding of your costs, you will need to decide on your pricing strategy. There are a variety of approaches to doing this but, as with so much else in running your own business, there is no magic formula. The most simple methods are cost-plus and cost-times. (See Table 8.3.)
Table 8.3 Cost-plus and cost-times
Cost of Cost-plus Cost-plus Cost-times production (cost plus (cost plus (two times
(incl raw £30) 10%) multiple
materials) of cost)
Price £100 £130 £110 £200
Profit – £30 £10 £100
Note: Cost-plus and cost-times are very similar. Cost-plus is in fact the same as cost- times if you are using percentages (cost plus 10% is the same as cost times 1.1).
Generally cost-plus, whether you use a fixed amount or a percentage, is used for contracts where the costs are not predictable until you start work, or in public service and internal contracts where maximizing profits is not the objective.
However, these methods do not take account of the market.
Your customers do not base their purchase decision on whether or not you cover your costs. Customers choose to purchase on value for money and price comparison. Therefore, while you clearly have to be able to charge more than your costs, you also have to keep your costs at a competitive and attractive level for the market. The prices of many everyday goods and services are well known to the market, and thus your room to alter pricing is very limited; there is an accepted going rate, which you can undercut but not exceed. If your goods or services are unique or exceptional, then your room to alter prices is much greater. Economic theory provides a range of rules and equations to discover your ‘price elasticity’, which you may be interested to learn more about to build up a good working understanding of your business (see Financial Management for the Small Business, Kogan Page/The Sunday Times, 6th edition, 2006). However, this is by no means absolutely necessary, as you will probably have a fair idea what price level your business can sustain.
To choose your pricing policy successfully you must know what your sales will be. This is clearly not information that is available before you start to sell. As such you have to estimate what level of sales you expect to achieve. Let’s take a simple example of a plumber. He knows that his overheads for any given week are the repayments on his vehicle and its running costs, his professional indemnity insurance, his advert in the local paper and what he pays his bookkeeper. This totals £100 per week. He expects to have three jobs a day and work five days a week. That is 15 jobs a week. In pricing scenario 1, if he charges himself out at
£20 per call out and the first hour, plus £15 per hour thereafter, and each job lasts two hours on average, he can expect £35 per job, or £525 per week. He then deducts his £100 for costs, leaving him with £425 profit for the week. If he has incorrectly estimated his number of jobs or the length of time they take, then his profit looks very different. (See Table 8.4.) In scenario 2, if he only averages two jobs per day of two hours each, then his week’s takings fall to £350. In scenario 3, if he still has three jobs a day but only of one hour each, then his takings will have fallen still further, to only £300, leaving him with only £200 after his over- heads. In this case he would have to increase his call-out charge to
£35 to return to his original takings figure, as in scenario 4.
However, the market may not support a 75 per cent increase in call-out charges, in which case his total number of jobs may fall yet again. Of course, the plumber will also charge out the ma- terials used in each job, and there is a limited opportunity for a profit here.
We see in this example that even where there are few variables that may affect your revenues, the impact of incorrect estimates is large and the effect on your prices therefore critical. Where you are a retailer with many items on sale and the need to attract a sizeable number of customers, the implications of your estimates become ever more important.
A few thoughts ought to be borne in mind when finalizing your pricing:
T First, decide whether you are marketing your business on quality or price. If your strategy is price-led, then you will need to create volume, and must be clearly cheaper than the equiv- alent level of competition. If you are quality-led, then low prices may send out the wrong impression.
T If you are a new business and do not know your correct price level, it is easier to start high and then lower your prices than to start too low and then discover that you need to raise them.
T If you believe that your goods or services are of a high quality, do not be afraid of pricing them accordingly.
T Make sure you have fully costed all your product or service inputs before finalizing your price.
T Do you have any goods or services that you can advertise as
‘loss-leaders’ to attract customers to your business?
T See the checklist at the end of this chapter.
Table 8.4 Plumber example
Scenario 1 2 3 4
No of jobs per day 3 2 3 3
Cost per call out £20.00 £20.00 £20.00 £35.00
Extra hours 15 15 0 0
Takings per day £105.00 £70.00 £60.00 £105.00 Takings per week £525.00 £350.00 £300.00 £525.00
Costs per week 100 100 100 100
Profit per week £425.00 £250.00 £200.00 £425.00