May  2004      Vol. 13, No. 5  REAP HOME PAGE  A publication of the Center for Rural Affairs    
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Pricing Your Product or Service
Determine your cost structure to know your price floor.

Understanding your costs is a critical component of establishing the price for your product or service. Determining the cost “floor” for your product is an important step toward establishing the range of where your price should be. This will help you understand where you can exercise pricing discretion to set your price point.

Pricing at the floor means that you are not making any money, or margin, on the products you sell. It is also called the “break-even” point. The price of your product or service must be greater than your total costs. This may seem like common sense, but many business failures have occurred from not fully understanding the total costs they incur to produce the product or provide the service to their customers.

Understanding your total costs requires you to conduct an accurate assessment of your variable costs and your fixed costs. Your variable costs are those associated with each product you create. Raw materials and labor expenses required to create products are examples of variable costs.

Fixed costs are those costs that remain constant, regardless of the volume of product that you produce. Rent and utilities are examples of fixed costs. Fixed costs may be more challenging to assess. Fixed costs may be allocated based on a prorated factor based on the time associated with creating the product or providing the service. This is more complex when multiple products or services are being offered.

Calculate these costs as accurately as you can to find the price floor. This exercise will make certain that you don’t price your product or service too low and prevent you from making a profit from each unit sale.
In determining price, one also has to consider the customer’s perceived value and its correlation to the price that they will pay to benefit from their purchase. Be careful not to price too low and run the risk of the perception of low quality.

In addition to the cost structure, the price point may be determined by:

  • Level of demand
  • Degree of competitive threat
  • Impact of government regulation
  • Presence of substitute products
  • Product positioning
  • Production and distribution capabilities
  • Overall marketing strategy

Even after you have done the analysis, pricing is still a bit of magic. Often, a little luck is involved.

Source: On Target: The Book on Marketing Plans, Tim Berry & Doug Wilson, 2001. 
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