One of the great difficulties that entrepreneurs and entrepreneurs face is finding the right selling price for their products and services. This cannot be very cheap, because it can generate mistrust in the quality of the product coupled with the null profitability of the company. You also cannot apply a high salling price because customers will prefer to buy from the competition. In the end, the goal is to find a price that is attractive to the customer, without risking profits to be profitable in the long term.
To know the selling price of your product or service, it is important to keep in mind the costs, expenses and the desired benefit. With these elements, it is possible to use a formula that will help us to know the right selling price for our product or service. The procedure is the next:
Elements to calculate the selling price
The elements of the formula are represented as:
- PV = Selling price
- C = Production cost
- R = Profitability ((benefit / utility))
Formula to calculate the price of a product
Let’s uppose we are the owners of a pastry shop and we want to know the price at which we should sell a cake. We know the production cost of that cake is £5.00 and we want to make a profit margin of 30%. Based on the above formula, the result is as follows:
PV = C / (1 - Profitability)
Values are replaced:
The formula that we are going to show applies with respect to the price without VAT. So, we apply the following: 30% divided by 100% = 0.30.
Then we subtract 1 minus 0.30, which gives us a result of 0.70
And finally, we divide the production cost which is £5.00 by the percentage of profitability; or in other countries called (benefit / utility) which is 0.70; as shown in the calculation above.
The result indicates that in order to achieve a profitability (benefit / utility) of 30% for a cake that cost us £5.00 to produce, it is necessary to sell the product at £7.14 (price without VAT).
If we want to check the result, we use the following formula:
Values are replaced:
The expected profitability for the product of 30% is confirmed
Add VAT to the product
Finally, if you want to add VAT to this product; the approach is as follows:
£1.50 of VAT will be paid.
The final selling price when adding (tax base + VAT) equals £8.64 British Pound.
Selling price = £8.64 British Pound
It should be noted that although there is a formula to calculate the value of a price, in most cases it can be influenced by external factors that modify the final result.
Among the factors that can affect the selling price are:
The competition. If you find yourself in a very competitive market, the profit margin you expected to obtain may decrease if businesses offer the products at lower prices. Sometimes, you will have to offer discounts to customers in times of low sales or on special occasions, so this entails a readjustment in the profitability that you would expect to obtain.
The market. This element allows you to know the interest of people towards the price of your product or service and the number of people that can purchase them. Based on what the law of supply and demand dictates, the higher the supply, the lower the price of the product, therefore, the expected profitability as well. With higher demand, the selling price increases, and the profit margin can be adjusted based on that demand. It is recommended to be aware of these changes in the market and readjust when necessary the selling price of the product or service.
Consumer behavior. This aspect is changing with macro trends worldwide, for example, today we see consumers more concerned with aspects such as healthy food, organic products, etc. If you are not aware of changes in consumption, it is likely that you are offering your products below the average price or above the average, depending on the sector. For this reason, it is recommended to inquire about changes in customer consumption to modify the selling price.
Fixed costs and variable costs. Any change you make in this area will cause a change in the formula; Whether you increase costs or decrease them; profitability will change. For this reason, you should have strict control at this point to avoid working only to cover expenses.
These elements are just some of those that can directly and indirectly affect the selling price of a product; in this article we mention the most important ones. In the end, make sure the price and sales volume allow the business to be profitable. Do not forget to be clear about your price, your maximum costs or your margin to modify them depending on the situation in the market.