Price setting directly determines your profit margin, which affects how fast losses are recouped as well as how quickly the company can profit.
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Demystifying Cost Of Goods Sold (COGS)
COGS may seem intimidating but is actually a concept that can be understood easily. COGS lets you know how much it costs to deliver your offerings to a consumer. The cost should vary according to sale, and should only be incurred when something is sold.
With that in mind, COGS can include the cost of wholesale supplies, transportation costs, storage costs, manufacturing costs and more. In the event that certain costs are shared across functions, you can divide the cost either equally across each function, or proportionately based on each function’s size. For instance, when you ship many products together in a bulk shipment, the shipping cost can be split according to the type of goods.
If you are unsure whether your COGS is accurate, seek help from an accountant or bookkeeper.
Calculating profit margin
After figuring out the COGS, you will be better equipped to set a selling price. If your selling price is higher than your COGS, you will be making a profit. That profit, also known as the mark up that you add to the COGS, is also known as the profit margin.
The profit margin differs across industry and company scale. If you are operating a virtual company on your own, you are likely able to live with a small profit margin since you do not have costly rental or overheads such as employee salary or utility bills to pay.
It is important to note that not every price has to be set at a profit. For instance, you may need to get rid of a product at cost price to get rid of the item to prevent further losses. You may even need to provide a complimentary service to encourage loyalty or redo a poorly done service for a customer for free.
Pricing your offerings
It is useful to first examine the macroeconomic environment that your company is operating in. By doing research on how much other close competitors are charging, you will be able to come up with a rough estimate for your services. From there, you can decide to change your price according to your business strategy.
If you have a highly differentiated product that will greatly add value to consumers’ lives, or if you expect the product to shake up the industry and be in high demand, you will be able to command premium prices that go above the market rate.
If you are unable to do that and would like to compete with price instead, you can charge below the market rate. By doing so, you will be targeting price-conscious consumers and may have to work within low-profit margins.
Of course, you can match the market price by being a price taker as well. This way, you fit into the average expectations of consumers paying for similar offerings.
While stagnant prices offer consumers stability, prices need not always remain the same. For instance, you may need to lower your selling price, and hence profit margin, in the initial launch of your business to attract attention and penetrate the market. By holding these newly acquired consumers for a period of time, you can build reliance and possibly brand loyalty for your product. Over time, you can slowly increase your price up to the intended price. Many companies also have a trial price that is only a fraction of the original cost in a bid to gain traction. Many subscription services such as Classpass, Netflix and Spotify offer free limited trials as well.
Alternatively, you can set a very high price, in the beginning, to tap on the appetite of early adopters who are willing to pay a premium to gain access to the product as soon as possible. Prices can then drop over time. This taps on the idea that innovation diffuses over time as a product is spread through the social system. This is especially useful if you are a large brand with a great product and strong following. Apple is a prime example of that.
You can also engage in product bundling to sell more products at a slight discount. While the overall profit margin is reduced in terms of percentage, the lump sum revenue generated is higher. To successfully execute this, there is a need to conduct researches on the ideal combination of products and services to bundle up. For instance, there may be an ideal number of same products to bundle together as a bulk purchase. Examples include a pack of three dishwashing liquids, a 12-month long subscription for healthy snacks, and more. Alternatively, you can bundle different complementary products. For instance, consumers may want to purchase a variety of television channels for a period of time, or they may want to buy a toothbrush and a toothpaste as a set.
Price directly affects demand, which forms the backbone of your business. Knowing how to calculate COGS, and setting an appropriate price is fundamental to success.
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