A critical factor in any business is developing an effective pricing policy that will maximize profits. Maximum profit does not necessarily result from selling goods at the highest possible profit margins. There is a relationship between the price, volume sold, cost of merchandise, and operational expenses that ultimately determines profitability.
Although increasing price may result in a decrease in sales volume, this approach may actually generate a greater total profit. If sales volume is too low, however it may decrease total profits. Alternatively, dropping prices may create a large enough increase in sales volume to generate greater total profits. Again, if volume is not increased enough a lower profit total may result.
An important factor in any pricing decision is to know the actual cost of doing business and the cost of each product sold. Determining the actual cost of doing business necessitates careful, accurate analysis. Of course, no one would be expected to calculate the cost of doing business with complete accuracy. You just need a fairly close working number.
It does, however, need to be fairly accurate since failing to calculate all actual costs properly to ensure that the profit margin is enough to cover those costs is a frequent cause of business failure. Many business owners actually end up selling their products at a loss without even knowing it.
The estimated cost of finished or raw materials, labor, indirect overhead, and research and development must be determined before setting the final selling price of items. These factors must be re-evaluated as costs fluctuate.
No matter what approach you decide will achieve the maximum levels of profit, the approach for determining product costs will involve four expense categories. These categories are: Labor Costs, Materials Costs, Overhead Per Unit and the Desired Profit Margin.
Combining these factors allows you to calculate an item’s minimum sales price. A detailed explanation of this method can be found at the resource listed below.
Proper product pricing is only one factor in developing a profitable plan. Another major factor to be determined once you know your costs, break-even point, and profitability goals, is the selling strategy. Three main sales approaches are used (sometimes concurrently) by businesses to develop a final pricing policy that will allow them to compete successfully in today’s market.
As you can see there are many factors to consider when determining a products final price. Although many businesses try to compete on price alone there are many others that compete on value by offering a more effective product or by finding a niche in the market that is being under-served or not served at all. Regardless of your market approach, it is essential that you analyze and understand all the factors relating to your product pricing.
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