Pricing

In short

I once watched a friend of mine close his bakery after three good years, and the sad part was that the line out his door never shrank. He charged too little. If you are pricing something you make or sell, start by writing down what each unit costs you, including your own time. Add the share of rent, insurance, and tools that each unit has to carry. Then decide what profit you want on top, and check that the final price still makes sense to the person buying. Raise it gently and on purpose, rather than hoping the books will sort themselves out. A price is a promise to your family as much as to your customer.

The whole of it

What it is

You have probably stood at a counter and wondered what to charge for the first time. I did that once with a handful of fence posts I had split, and I guessed. I guessed low, because I wanted folks to like me. That is a very human mistake, and a fixable one.

A price is the amount a customer pays for what you sell. It has to do three jobs at once. It has to cover what the thing cost you to make or buy. It has to pay a fair share of the costs of keeping your doors open. And it has to leave something behind, which is your profit. Profit is the money left after every cost is paid. It is what lets a business grow, pay its owner, and survive a slow month.

There is a fourth job that gets less talk. The price tells the customer something about the product. A very low price can make a good thing look cheap. A fair price tells them you stand behind your work. The people who buy from you deserve a seller who is still in business next year.

How it works

Start with direct costs. These are the costs that rise and fall with each unit you sell: flour for a loaf, lumber for a table, the hour you spend on a client's job. Next come fixed costs, also called overhead. These are the bills that arrive whether you sell one thing or one hundred, such as rent, insurance, software, and your phone line. You spread overhead across the units you expect to sell. If overhead is $2,000 a month and you expect to sell 500 units, each unit carries $4.

Now add the two together and you have your cost per unit. Say a unit has $6 in direct costs and carries $4 of overhead. Your cost is $10. Selling at $10 means you break even, which is a fine word for working for free. So you add a profit. One way is a markup, which is a percent added on top of cost. A 40 percent markup on $10 is $4, so the price is $14.

Many owners also talk about margin, and the two get mixed up. Margin is the profit as a share of the price, not the cost. On a $14 price with $4 of profit, the margin is 4 divided by 14, which is about 28.6 percent. A 40 percent markup is not a 40 percent margin. Mixing them up is how people think they are earning more than they are.

The numbers, and where to find yours

Most of the figures you need are already in your own records. Your direct costs live in your receipts and supplier invoices. Your overhead lives in your bank statements and your bills. Your own time is the cost people forget. If you work 20 hours to make something and you value your hour at $25, then $500 of labor belongs in the cost, even if no one writes you a check for it.

You will also want a sales estimate, which is how many units you expect to sell in a month. Be honest and a little cautious here. If you guess too high, your overhead per unit looks small, and your price comes out too low. Use last year's real sales if you have them.

There are a few figures set by law that touch pricing. If you sell goods, your state may require sales tax, and the rate depends on where you are. Check your state revenue department's own website for the rate and for which items it covers. The IRS also publishes the filing rules for business income on its website, in the guide called Publication 334, Tax Guide for Small Business. If you hire help, the minimum wage is set by law, and the current federal figure is the current figure, which the official source publishes each year. Your labor cost has to sit at or above whatever applies where you work.

A worked example

A woman I will call Maria makes handmade candles in her garage and sells them at a weekend market. She asked me what to charge, and we sat down with a pencil and the back of an envelope.

Each candle uses $3 of wax, $1 of wick and jar, and $1 of label and box. That is $5 in materials. It takes her 30 minutes to pour and finish one candle, and she values her time at $20 an hour. Half an hour at $20 an hour is $10 of labor. Her direct cost is $5 plus $10, which is $15 per candle.

Her overhead is the market stall fee of $120 a month, $40 for insurance, and $40 for a small online shop. That adds up to $200 a month. She expects to sell 100 candles a month. So $200 divided by 100 candles is $2 of overhead per candle.

Her full cost per candle is $15 plus $2, which is $17. She wanted a 30 percent markup. Thirty percent of $17 is $5.10. Her price comes to $17 plus $5.10, or $22.10. She rounded to $22, and later to $24 once she saw how fast they sold.

Here is the part that made her smile. At $22 she earns a profit of $5 a candle. Over 100 candles, that is $500 a month on top of paying herself $20 an hour. Before the envelope, she had been charging $12. At $12 she lost $5 on every candle and worked for nothing. Good work, Maria. The candles were never the problem.

Where it goes wrong

A friend of mine once priced everything by checking what the shop down the road charged. It felt safe. But that shop had a different rent, different suppliers, and maybe a different goal. Copying a neighbor's price can copy their trouble too.

The most common slip is leaving out your own time. Another is forgetting overhead, so the price covers the wax but not the roof. A third is mixing up markup and margin, as we saw, which makes profit look bigger than it is. Some owners also set a price once and never look at it again, even when costs climb. If your supplier raises prices, your own price has to be checked that week.

Fear does the most damage. Many of us worry that a higher price will chase people off. Sometimes a few leave. But the ones who stay are often glad to pay for good work, and they tend to complain less. Raise a price with a kind word and a clear reason. Customers respect a seller who explains.

Questions to answer before you leave this page

Have you written down what one unit really costs you, including an hour of your own time at a fair rate? Do you know your monthly overhead, and how many units you honestly expect to sell to carry it? Is the profit you want a number you picked on purpose, or one you drifted into? Would your price still leave something after a slow month, a broken tool, or a supplier raising costs? Do you know whether your state wants sales tax on what you sell, and where to look it up? And when did you last check your prices against your costs, instead of against the shop down the road?