Should I Change My Pricing?

I have a small startup selling gardening tools and services and I am having a problem with pricing. I am making sales, but my friends have told me that I am priced too low. I’m afraid that raising my prices will scare off my existing customers. What should I do?

Anonymous

Dear Gardening Guru,

You are not alone in your pricing concerns. Most businesses price their goods and services too low and the best way to determine if that is the case for yourself is to evaluate your gross margin ratio. Looking at numbers may scare you, but you will be happy when you see the money in your bank account growing.

What is Gross Margin and the Gross Margin Ratio?

Gross margin is your net sales (the money that you receive from your customers) minus the cost of goods/services sold (the direct costs associated with producing the goods or services). The gross margin ratio is determined by dividing the gross margin (net sales – cost of goods sold)/net sales.

The purpose of these calculations is to show how much money is left over to pay for your other expenses including rent, marketing, loans, utilities, employees, etc. As a rule of thumb, you want your gross margin ratio to be, at a minimum, 45%; thus, your prices should be the unit price to produce the good or service + a markup of 45%.

 

How to Determine Your Prices

From the little that you have told me about your business, I will make a few assumption on what products and services yo sell. As an example, I will assume that you sell only one variety of pots and you do landscaping as a service for residential homes.

 

 Pricing a Product

 

In my example, your pots are your product and you get them from a supplier.

Unit Cost of Goods Sold: Cost per Pot + Direct costs (these are variable costs as they are directly affected by how much product you purchase).

Unit Cost of Goods Sold = $5.75 (cost per pot from supplier) + $10 (avg. unit cost of transportation and delivery)

Unit Cost of Goods Sold =$15.75

(If you produced the pots in house, then you would add labor and materials to your cost)

 

Minimum Unit Price: Unit Cost of Goods Sold x Markup of 45%

Minimum Unit Price=  $15.75 x 1.45 = $22.84

 

Are you making enough?

Analyze how much you have to sell to cover all your additional costs (rent, salary, equipment, loan, insurance, marketing, etc.)

E.g. If you sold 1,000 pots, how many will be left over?

 

Net Sales (pots sold x price): 1000 x $22.84 = $22,840

Cost of Goods Sold (pots sold x cost of goods sold): 1000 x 15.75 = 15,750

Gross Margin (Net Sales – Cost of Goods Sold): 7,090

Other Costs: (Employee salary, rent, insurance, marketing etc.)/month $10,000

Earnings before interest, taxes, depreciation and amortzation (Gross Margin – Other Costs): – $ 2,910

You actually need to sell 1,411 to cover your business costs.

 

Pricing a Service

The majority of service businesses assume that there is no cost to produce their service. Wrong! Your main cost is time and labor. If you are the one providing the service, how much is your hourly rate? If you hire others, what is their hourly rate?

In you case, Gardening Guru, let’s assume that your service is landscaping and you hire contractors.

Unit Cost of Services Sold:

Average amount of work: 5 hours per job

Labor cost: $20/hour = $100 per job

Transportation and gas (to get to the work site): averages to $50/job

Cost of Services Sold per job: $150

(If you have to rent equipment, then some of that cost should relate to the cost of service.)

 

Minimum Unit Price: Unit Cost of Goods Sold x Markup of 45%

Minimum Unit Price=  $150 x 1.45 = $217.50

 

Are you making enough?

Analyze how many jobs you need to do to cover all your additional costs (rent, salary, equipment, loan, insurance, marketing, etc.)

E.g. If you did 100 jobs in a month, how many will be left over?

Net Sales (number of jobs x price): 100 x $217.50 = $21,750

Cost of Goods Sold (number of jobs x cost of service per job): 100 x $150= $15,000

Gross Margin (Net Sales – Cost of Goods Sold): $6,750

Other Costs: (Employee salary, rent, insurance, marketing etc.)/month $10,000

Earnings before interest, taxes, depreciation and amortzation (Gross Margin – Other Costs): – $ 3,250

You actually need to do 149 jobs to cover your business costs.

What to Do if You Priced Too Low

 

Even marking up your product or service by 45% may not be enough. If you are a service business, you are bound by time on how many clients you can serve. In addition, it may be unrealistic for you to sell 1,000 every month just to cover your costs.

Here are four things you need to consider in your pricing strategy:

1. Buy Right

Know what is your fastest moving product, then get that product at a discount from your supplier. Only buy in bulk if you know that you can move your inventory quickly. Having too much inventory is like having tied up cash: you’ll resort to discounts to move it and you have to pay to store it.

2. Assess Your Markup

45%  markup may not work for your industry or brand. A luxury brand demands a larger markup. Industry practices can also give you an indication of whether you are priced too low.

3. Be Careful with Discounts

Not all products should be discounted and those that are should not be lower than your minimum price; pricing at cost will not pay for your business expenses.

4. Invest in Good Systems

If you are selling a product, buy a great inventory system that will track your products and will take the guess work out of pricing. If you are selling a service, keep your books up to date with great accounting software. Do not hesitate to hire an accountant to help you manage your finances, especially if you are having trouble determining what your costs are.

5. Increase Your Prices

You can either increase your prices slowly, e.g. 10 cents a month, or altogether. If you can afford it, go the slow route. Choose to change only one product at a time and start with the slower moving products. If you need to change your prices right away, one at a time, put some time into rebranding and being very clear of the value of your product or service.

 

I hope this all helps!

 

Rosie

Rosie Ogang, PFP, CPA, CMA

Rosie is a talented Senior Financial Analyst with a proven track record of providing comprehensive financial forecasting, budgeting, and analysis to senior management at Fortune 500 organizations. Her work helps improve organizational decision-making, which results in increased profitability.

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