Pricing

Pricing

How you price your products or service will have a direct effect on your ability to make sales, and stay in business. In every industry there are normal mark-up percentages that will give you a starting point. For example, typically in the restaurant business the gross margin is 67%, or stated another way, food cost is multiplied by three to get the sale or menu price. Of that menu price, food cost is 33%, labor is 28% to 35%, and the balance has to cover everything else, and leave a profit. Given that information you would take your food cost times three, and compare the result to your local competitions prices to see if you can make money at the menu price you arrived at. From that starting point, you adjust your prices based on the market, and your business's ability to charge more. What is special about your business that the customer will pay more for? The possibilities include service, location, delivery, exclusivity, ambiance, extra features, image, etc?

Most beginners make one of two errors when pricing that are easy to avoid. They either over price the product or service, or they under price them. In the case of over pricing, the price is set by taking the cost to produce, and adding an arbitrary profit, and saying that is my price. The problem with this approach is that it ignores the rule of supply and demand. What a product or service cost you, or how much you want to make, has little to do with the sales price. To avoid over pricing your product, and getting few or no sales because of high prices, start with the market price for the product or service, and subtract your cost to provide the product or service. What is left is your gross profit margin. You can either make a profit with that number or you can't. If the profit margin is to low? you will need to re-think your strategy. Look at it this way, if your competition can make a profit at those prices, you need to find out how they do it, or sell something else. Very few people are successful going against the market driven prices.

A bigger problem beginners make, is under pricing the product or service. The reason for this is that that they do not take into consideration the real overhead cost. When calculating your cost of doing business you need to include everything, freight in, labor (at the rate it would cost you to hire someone to do the work, including your employer taxes), boxes, labels, rent, warehousing, etc. etc. After you know your total cost of supplying your product or service, your profit margin has to be high enough to pay for all of the business's expenses, and make a profit large enough to grow the business. The more common things beginners forget to account for in their business expenses are warranty cost, customer service, returns, credit card fees, bad account write offs, payroll taxes, labor at the going market rate, warehousing cost, and advertising cost. In the beginning you may be the chief cook and bottle washer, but eventually you will need employees. Will your prices support the future business growth? If you cannot get high enough prices now, you probably won't be able to later on when you need to.

Pricing Formulas.

It is best to set your prices, using the industry standard markups for the industry you are in. Vender sales representatives who serve the industry can usually provide this information. Having said that, I start my pricing using the following formulas when I do not have other information to work with. For products; I take my landed cost time two (cost 1.00 x 2 = a $2.00 sales price, a 50% gross profit). For services; I take my cost to provide the service, times three (cost 1.00 x 3 = $3.00 a 67% gross profit).
The formula to calculate gross profit % is, sales price, less cost, divided by sales price = % of gross profit.

Break Even Point.

Take your estimated cost to operate (ECO) for one year, divided by your gross margin (GM) % = break even (BE) dollars. (ECO divided by GM % = BE $)

If your gross margin is 33%, and your operating expenses come to $72,000 per year, you will need $218,000 in annual sales to break even. $72K divided by 33 = $218K

At a 40% gross profit margin your break even would be $180,000

Business Plan Example.

Johnny Q's Bar-B-Que's menu pricing was derived at by by calculating a 67% gross margin and comparing the resulting individual menu prices to other barbecue restaurants with in 200 miles of us. We then compared our plate prices and average ticket prices to the local competing sit down restaurants and adjusted prices accordingly. The goal was to set prices as high as possible while keeping our prices comparable with those of our customers other dining venue choices. Our food cost varies between 28% and 33% our labor cost will vary between 28% and 35% and our average gross profit margin after food cost and labor will be 36%. Our break even will occur on sales of $16,600 per month. See attached menu.

Catering margins were similar 36% food cost, labor at 26% is higher then our restaurants do to waste factor but labor is more efficient serving larger numbers of plates in a shorter time frame.

I would include a copy of the proposed menu, average ticket price, list of catering prices, etc.