Two Simple(ish) Steps for Pricing Your Product for Profit
Note: This article is based upon a talk I gave at Vend Raleigh's 2015 Illuminate conference. I've shared the PDF so many times over the years it seems right to share it here with my small business friends. Honestly, it is still relevant for me even though I've moved from creating pillows back to creating fabulous websites. Read more about that journey here. **There are affiliate links in this post. If you click through and make a purchase, I may receive a commission at no additional cost to you. Read more here.
I started my creative business in 2012 complete with a business plan, market research and personal seed money. My bright business idea was to provide monogramming services for the families at my children’s school, where uniforms rule and having your name on your backpack and lunchbox is one of the only forms of personal expression the kids have.
Roll forward to the end of that first year, my business plan had fallen to the wayside and I was $14 million in debt. Just kidding... but I was in debt.
Why Price for Profit?
Now my business story above leaves out an important element - my cause. You see, whatever your business story, you are in business first and foremost to make money for your cause.
What is your cause? Bring it to the front of your mind right now. My cause is my daughter’s tuition. As an auditory learner, she requires a smaller quieter classroom. Those classrooms cost money friends.
I could have returned to a corporate job and easily made her tuition money, but as a former latch key kid I am determined that my daughter and son will never have to come home to an empty house. They will never experience that kind of loneliness while they are under my roof.
See how quickly we can get off track when we think of all of the personal reasons behind our business story? So when you think of your cause, don’t pull out the whole story. Just isolate that financial cause in your mind. For me, it's Tuition Money.
Reach Your Financial Goal
Every business has specific financial goals. Target and Apple set financial goals every quarter and so should you. If you don’t set a goal, how will you reach it?
It is easier to develop a pricing strategy when you have a tangible financial goal to work toward and compare against. So, what's your financial goal?
Hint: It’s the amount of money it takes to fund your cause. Mine is: 7,171.00 (my daughter’s annual tuition)
Got Profit? Or is Your Business a Hobby
The IRS says that if your business does not make a profit for 3 out of the last 5 years of business it is a hobby. So there it is, if you don’t price for profit, you have a hobby. There is nothing wrong with having a hobby, but you lose those self-esteem building bragging rights “I run my own xyz business.” Oh and say "Bye-bye!" to that juicy Home Office Deduction.
How to Price for Profit | In Two Simple(ish) Steps
The process of pricing for profit begins with analyzing each product and service you offer One-At-A-Time. When I went through this exercise for the first time, I procrastinated this step because it was HARD. Re-pricing all 61 of my products... With Math?
The answer is - Yes! Because that’s the only way to do it. You have to do the math. Have to.
Truthfully, as soon as I re-priced one item and saw how much of my work I was giving away (or in some cases paying people to take!), I was energized to push through and get my pricing right. I also got smart after I worked through my first product and created a spreadsheet to do the hard work for me. But you don’t need a spreadsheet, you can definitely do it all on paper.
Breaking it down, there are 2 simple (ish) steps in the pricing process...
Step 1: Know Your Costs
There are 3 kinds of costs related to business:
- Material Costs
- Time Costs
- Overhead Costs
Let’s talk about each..
This is whatever goes into making one of your item:
¼ yard fabric
2 sticks of butter
Now if you have a service based business, you might feel like you have no material costs, but what about that that Bon Bini Print thank you note you give every client or that set of worksheets you print out?
Anything you can breakdown to this granular level put it here. If you use something that can’t practically be allocated, like a spool of thread, we’ll include that in the overhead section.
These are all the things you pay for through the year that don’t directly go into
making your product.
- Webhosting or eCommerce website fees
- Credit card processing fees
- Your laptop
- Printer ink and paper
- Studio rental
- Equipment costs
- Shipping materials, etc.
- And anything you use that can’t be broken down to the product level (like thread and paint).
About a year into my business, my husband had the audacity to ask me if I accounted for my time. What a jerk, right?
He does have an MBA so maybe he was on to something. But in my mind, I wasn’t doing anything else with my time so what was it worth? Then this vision of the future came to me....
...Picture this: You get a phone call,
Hi! This is Marla Silver an editor for Martha Stewart Living, I just wanted you to know we are featuring your widgets in next month’s edition.
The article is published and you are rolling in the orders thanks to your new found fame...
...Until you find yourself not sleeping because there simply aren’t enough hours in the day to get orders out on time. You know you need to hire someone but guess what, you didn’t account for your time in your pricing. Just your materials and luckily your overhead. If you start paying someone to make your widgets, your business will lose money!
Are you convinced of the importance of accounting for your time yet? Tracking time costs is simple - set a timer, figure how much time it takes to make that widget and multiply that number by how much money you want to be paid per hour. Get stared quick, before Martha's spotlight shines on you!
Oh wait, even if you do start accounting for your time in your price, think a little further down the road. You get so busy filling your Martha orders you've decided to hire that help. The bad news is if you have to pay a worker the wages your planned for yourself, now you won’t make any money off the work they do for you unless you added in a Profit Margin to your product. It's not as bad as the losing proposition you were in before accounting for your time costs, but aren't we in this to meet your Financial Goals?
Whether you make a product or sell a service, if you hire someone without a profit margin worked into your pricing, you will make no money. So let's get to Step 2 and define your pricing equation where we'll spend a bit more time working out this Profit Margin thing.
Step 2: Choose Your Pricing Equation
Now, this part should be simple, right?
Profitable Selling Price = Materials Cost + Time Cost + Overhead Cost + Profit Margin
- Materials Cost = add up the cost of everything that went to make one of my things
- Time Cost = take the hours I worked on making my thing and multiply it by what I want to earn per hour.
- Overhead Cost = …..
Wait a minute…. How do I attribute that big lumpy Overhead Cost to each individual product? And how do I Decide what my Profit Margin is? These are great questions!
Accounting for Overhead Costs
I’m going to be honest. To me, accounting for overhead costs feels like a big guessing game.
You need to predict how many hours you will work or how many units you will sell and then
use a calculation to generate an overhead surcharge that you add to every product or service.
Honestly, it’s sketchy at best. But overhead costs are going to exist and it’s better to at least
make guestimate and put money aside to cover them rather than choosing to close your eyes and pretend they aren’t there.
Here are Three Methods for Developing an Overhead Cost Surcharge
Method One: Time Based
Overhead Cost per Hour Worked= Annual Overhead Cost / Annual Hours Worked
- Annual Overhead Cost: Add up your anticipated overhead costs for the year (use last year’s costs if you are unsure)
- Annual Hours Worked: Add up the hours you plan to actually work this year and bill for (don’t forget to take away for vacations, sick days, etc.)
Here's an example: If your Annual Overhead Cost is $3000 and you work 20 Hours per week for 30 weeks = 3000/600 = an overhead cost surcharge of $5 per hour
Method Two: Ten Percent Rule
(Materials Cost + Time Cost) x 110%
This method is straightforward. Add up your materials cost and your time cost and then
add 10%. Scientific, am I right? Ok, it's not but it's easy!
Method Three: Materials Based
Materials Cost x 2
This is how I account for overhead. It’s a method I learned from Kitty Stein’s book Price Your Work With Confidence. I feel like it’s simple and raises the price relative to the items
existing base price rather than blowing the whole thing up like Method Two's Ten Percent Rule.
Determine Your Profit Margin
Etsy says this about accounting for profit...
“Where do you want this business to go? Do you want to quit your day job? Do you want to pay off a student loan? Accounting for profit now will help you get there. This number really depends on what you are selling, and will make up for someone like a printmaker, whose material costs are low, labor hours might be low, but should be paid for their unique talent and point of view!”
Vague, right? The point here is profit margin is personal to you and your product or service. Play with the numbers until it looks right.
Here is how I reasoned out my Profit Margin:
My family trees pillows take about 7 hours to create from design to shipping. It is a very, very tedious product. Priced without a profit margin at $172 (7 hours x $20/hr + $16 materials + $16 Overhead). I tacked on a $15 profit margin because honestly, it’s what felt right. And at $189, this pillow is one of my best sellers. I build profit margin on a per product basis.
Some products can handle and DESERVE a bigger profit margin than others.
Now you just have to do the math and then put your new prices out there into the world. Simple right? But are you worried about how your customers will react to your new pricing? You are not alone. Read on for a few thoughts on the topic of your customers and your prices.
How to Get Customers to Buy Into Your Price
It starts with knowing what makes your work worth the price you are charging and then using those stand out elements in your marketing. Unsure of what your differentiators are? Here are some suggestions for discovering them:
1. Repeat the market research you (hopefully) did when you set your prices initially. However, when you do your market research this time, don’t focus just on price. What we really want to make note of is what is it that you offer that your competitor doesn't. Is it superior customer service, customizability, quality of materials, purpose or focus, a vibrant online community?
2. Ask your existing customers why they chose you – send a survey with a reward for completion. Or read the reviews they have written.
3. Review your customer reviews and make a list of their endearing words and personal descriptions of your work.
Now you armed with great stories and descriptions of the differentiating qualities of your products and services, it's time to highlight them in your marketing. Incorporate them in your photos, descriptions and even your customer service policies. Consider sharing those sparkling customer reviews and stories in your social media posts. There are whole classes on how to up your marketing game so I won't head down that path here.
One Final Story
I want to leave you with one more perspective on where you are today and where you could be.
I sold my first family tree pillow for $89. If you remember the math, that means I worked for 4 hours for free for this stranger and also gave her my $15 of profit. Essentially, I gave this stranger $100 to let me make a family tree pillow for her. Makes you want to cry, right?
But I did the work and I fixed my prices. I no longer have a hobby - work for free, cheap or paying people to take my work. This summer MY BUSINESS wrote the check to pay my daughter’s tuition bill.
Update: I use these same principles to develop my web design services pricing. The bad news is that pricing is not a "one and done" proposition. The good news is once you've done it - it's much easier to know what is reasonable and reflects both your effort and expertise. You should revisit your pricing for a "reality check" at least once a year. Good luck out there and make sure you keep working toward those financial goals!
Kitty Stein's book Price Your Work With Confidence
This book was lent to me by a friend and it set me on the path to fixing my prices. It's geared toward the home furnishings industry (drapes-makers), but the information is applicable to all trades. It is out of print and therefore very expensive to get your hands on. But I felt remiss in leaving it out. See The Boss of You below for something more pocket-book friendly.
Tara Swiger's class Pay Yourself (and Pricing 101) https://taraswiger.com/pay-yourself/
This class was what set me on the firm and final path to reconsider my whole pricing state of mind and strategy. It's everything we talked about today and some key next steps to help you develop additional profitable product lines and offerings. Life Changing!
The 3 Ps of Pricing Perception blog series http://www.productiveflourishing.com/the-3ps-of-pricing-perception-part-1/
This set of blog posts will re-affirm the mindset you need to have when developing your pricing strategy. Read all 3 posts in the series for the full effect. This was a suggested resource from the Pay Yourself course above.
Pricing Strategy book The Boss of You
Need to see it, touch it, feel it? This book brings all of the pricing strategies we've talked about and more into one place.
Etsy's The Art of Pricing
I list this because it's available now and it's free. But it only scratches the surface and really glosses over the impact of overhead on your profitability.