By Michael Thompson, Chairman-elect, SCORE NE Massachusetts
Once you’ve settled on your product (or service), the next challenge you’ll face is how to set the price. Eventually you’ll need all the relevant costs to determine if this will be a for-profit business or simply a hobby, but I always like to start out by doing research into how much I could charge. There are two reasons for this approach: it helps me zero in on my target customer and it encourages me to think about how I could differentiate my offering.
One of the realities of consumer behavior when they are first confronted with a new product is that they will attempt to relate it to something in their experience. This leads them to a value determination. In other words, they immediately draw a conclusion that a product is more or less expensive that what they already know. So the goal of your preliminary pricing research is to determine what most consumers think about your product category. But not just any consumers…you need to figure out who is most likely to be interested and target that group exclusively in your questioning. And remember the most reliable research is objective, so avoid your friends and relatives.
If most people think your product is too expensive, this will give you an opportunity to mention the features and benefits and find out first-hand if your consumers value these factors in the same way you do. If most people think your price is a “deal”, then you can learn how you might adapt your offering to increase its value. That’s important because most start-ups have lower volumes and consequently higher costs. It’s critical to sell your product at the highest possible price which will allow you to cover your direct costs and leave some margin for overheads and marketing expenses.
Products that are tangible and purchased regularly are fairly easy for consumers to value. Their past experience tells them that items in this category usually sell within a small retail price range. On the other hand, services that are rarely used are much more open to varying prices. However, if you’re selling dreams, the sky’s the limit. Most of my own career was spent selling packaged biscuits which retailed between $2.00 and $4.00. A colleague I knew sold lipstick at almost 50 times its cost! But it had the benefit of being endorsed by one of the most beautiful women in the world.
Once you’ve completed your research and determined your suggested retail selling price, you then need to back off the relevant margins to calculate your wholesale price. Even if you plan to sell online (direct to consumers) this is a good discipline and protects your margins for the day you decide to place your products in stores. Again, research is necessary to find out the gross margin that most retailers need. And don’t forget to ask if a distributor is involved: that’s another margin you need to build in to your pricing formula. Distributors are often used when individual store volumes are low.
Finally, you should pull it all together in a projected cash flow statement, listing your various types of revenues (retail, wholesale) and deducting all your costs (shipping, direct product costs) to find out if your gross profit percentage is in line with your chosen industry. Most consumer products net a gross margin of 40% to 50% (less if the product is co-packed) and need that level of contribution to cover their selling & marketing costs, as well as overheads.
The power of price is the difference it can make in your consumers’ minds and to your bottom line. Take your time and get it right. And remember to err on the high side since you can always reduce it later, or give your customers a deal. Raising prices is always difficult and can sometimes be subject to justification.