When I think about the price and how to fix it, I always remember a joke that a friend of mine at the university liked to tell me:
I am one of the people who know the most about prices in this school because I always follow the course!
The fact that he repeated a year three times apparently has nothing to do with the story, hahaha.
The point is, we never understood why he repeated so much. It was a super simple subject in fact.
On the verge of anecdote, if I dare say.
In fact, everything that I learned during my studies and everything that I learned about prices during my career, I summarized in this article. If you want to know more about this topic (and don’t repeat the course if you have to take it in the future), read the article carefully.
Why is the price so important?
Many people spend little time thinking about the selling price of their services and products and this is a mistake. A serious mistake…
The price is one of the trickiest things about selling in different markets, and for three reasons.
The sale price is the only value reference for the customer
Often, whether your product is expensive or cheap, this is the primary way for your customer to assess whether your product is good or bad.
This is particularly important in technological/technical markets where the client is not always an expert.
Imagine you win the lottery and want to give a friend a hot-air-balloon because it is the dream of a lifetime. You’ll find 2 used.
- The first costs 750 €
- The second € 6,300
I bet you wouldn’t be very confident about buying the first one, getting in with your friend and flying with it…
With this low price (and the difference with the other), you suspect that there is a problem, a hidden defect. In short, something is wrong. This hot-air-balloon cannot be of good quality.
Well, the same goes for your customers with your product. Keep this in mind.
The sale price defines your income and your margin
Depending on the sale price you set, your turnover will be higher or lower and above all, your margin will vary.
If you have a lot of operating, marketing, and other expenses, you will need large margins.
For example, in catering, the market standard is to use a 66% margin on products.
33% is used to pay bills and wages and the remaining 33% is real profit.
The sale price determines your chances of attracting
If your selling price is very low and you do not have a very high margin, you probably will not be able to run advertising campaigns, unless you have a very high sales volume. In this case, you don’t really need to promote.
On the other hand, if you have a very high margin, you could go to great lengths to attract customers but you could also have an off-market price. You have to control these two variables to find the best possible balance for your product.
How to calculate the sale price?
There are three main methods for calculating the selling price of a product:
- By cost.
- By value.
- By the market.
Calculate the sale price by cost
This calculation method is ideal for all products and services that are a “utility”, a necessity.
To do this calculation, you must add up all your expenses and add a margin.
It’s going to be different if it’s a product or a service.
Calculate the selling price of a product based on its cost
This operation seems quite simple: you calculate the unit cost, you add a margin and you launch, but many people use the following formula which is incorrect:
The result does not vary by many percentage points from the actual result, but it is wrong. The correct formula is the following one:
Calculate the sale price of a service by cost
In this case, you must add up all your monthly expenses: advertising, management, office, etc.
Let’s suppose that the total expenses are 1,500 €.
Now, we would have to calculate the number of billable hours per month..
Let’s say about 120.5 a week.
Finally, you need to think about how much you want to earn at the end of the month before taxes.
Let’s say € 2,000.
You must therefore add up what you want to earn and your total expenses and divide them by your billable hours:
The result of the example would be € 29 per hour.
Calculation of the sale price in value
In my experience, this is usually the most attractive method of setting a price.
Unfortunately, it is not based on any predetermined formula.
The idea behind this calculation is to set a price based on the value or the results you will bring to the buyer.
Imagine that you are hired for an audit to better manage the stock of a warehouse.
After analysis, you calculate that once they have made the changes you are proposing, they will save € 30,000 per year in terms of storage, staff, and process costs.
On this basis, you decide the percentage of this value that you want to recover and you set your price.
For example, 33% of the value, or € 10,000.
If your product or service does not result in direct savings or financial gain for your customer, it is more difficult to calculate this figure, but you get the idea.
Instead of calculating based on what it costs you, you do it based on what it brings to the customer.
Calculation of the sale price by the market
It is the most “innocent” way of setting a price, but it is one of the most used.
- You want to know how much your competitors are asking for the same product or service as you.
- You lower it a little to beat them.
- Bing! You already have a price.
This is by far the worst way to set a price, but if you are determined to use it, at least think about how you want to position yourself:
- Do you want to appear as the cheapest and worst market?
- Or do you want to position yourself as the top of the range?
In my experience, the second option is almost always better, so if you use this method, keep it in mind.