The key to calculating your small business pricing model
- Written by Sharon Crombie, CEO & Founder, MicroChilli
Despite the challenges associated with running a business during the pandemic, the latest figures from the Australian Bureau of Statistics (ABS) reveal that the country’s business count grew by 3.8% in 2020-21. However, this accounts for an entry rate of 15.8% and exit rate of 12%, meaning over 277,600 businesses closed their doors over the period.
Poor financial management tends to be one of the key factors that contributes to the failure of small businesses, and the pricing model business owners set for themselves when they start out has an important role to play here.
Pricing and timing go hand in hand
Just like it’s vital to create a business plan to ensure there’s a need for your product or service before going to market, it’s imperative that you put the time aside to create your pricing model before you open your physical or virtual doors.
This is because it’s incredibly difficult to increase pricing once it’s been set. Customers and clients become accustomed to paying a particular sum for a product or service, and unexplained price increases can inevitably see them go elsewhere.
Adhering to a tried and tested formula
Following a proven formula can help you take the guesswork out of creating product and service based pricing. By ensuring it accounts for fixed costs, which remain the same regardless of the number of units you sell, and variable costs such as those incurred to make a product or provide a service that will change depending on the number of units sold, you’ll be much more likely to build a successful business.
Calculating pricing based on what you think might be right, can lead to undercharging and ultimately a company that is not sustainable in the long term.
Perfecting a product-based pricing model
Product and service pricing models vary. When it comes to setting product-based pricing, aim to follow these steps:
* Assess the costs involved in creating each individual product, whether that’s ingredients for a dish on the menu, materials for a garment, components for a piece of technology, or other.
* Set your hourly rate, and those of your future employees.
* Consider the time it will take you and/or your future employees to create each individual product you’ll be selling, based on the rates you set.
* Consider all other additional costs that are incurred annually as a result of you creating your product, such as rent, electricity, equipment and subscriptions.
* Add these figures up together as a whole, and then portion them out per product. If for example, you plan to sell 1,500 garments, calculate this overarching figure, and then portion it out per unit price to arrive at your end figure.
* Generally, businesses increase their prices on an annual basis, so ensure you repeat this process whenever you plan to adjust your pricing, so that you’re offering a competitive yet profitable rate per product.
Considerations when setting service-based pricing
For service-based pricing, it might seem like overheads are a lot lower so there’s less to consider, however it’s equally important to calculate this well in advance.
The following steps are key:
* Determine your hourly rate before anything else, and stick to it. This can be calculated based on your industry, niche expertise, and years of experience. Money really is a mindset here, so it’s vital that you remove any emotion and avoid undervaluing yourself to secure more business, especially in the early days. Steer clear of negotiating with a potential client if they don’t want to pay you what you initially set forward in your quote or proposal, because chances are you’re not a good fit for one another in the first place.
* Once you’ve figured out your rate, consider the number of hours each task or service will take you to complete. Depending on your business model, this can be calculated by either breaking your offering down into individual services, or monthly packages.
* Add between 20% and 30% gross margin on top of each service or package, to ensure you have margin – and cash – to cover the cost of overheads incurred as a result of providing your services, such as rent, equipment, electricity and subscriptions.
Whether you’re establishing a product or service-based business, determining your pricing in line with a proven formula before you launch will lead to a much higher success rate. At the same time, it’s not too late to take this route if you’ve already launched, in order to build a sustainable and successful business, however effective communication with customers and clients will ultimately be key here.