The Price Is Right

September 21, 2020
Warren More
Setting the right price is a critical, and often undervalued component, of running a successful business. Your price point not only needs to consider your costs, margin and competition but more importantly, your business model, strategy and objectives. For example, are you a new entrant, pricing aggressively, to grow sales against the incumbent players? Or are you a business that has a unique selling point that means you can charge a higher amount than your rivals? Do you want to be considered a budget brand (Hyundai), a premium brand (Maserati) or something in between (Audi)? Making sure ‘The Price is Right’ can go a low way to making sure your business is a success and you can do it by following these simple steps.

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For centuries, the exchange of goods was based on conversation, listening and a fair amount of haggling.  The price of goods was not set or presented but agreed.  In 1861 this all changed.  John Wanamaker, a Philadelphia department store owner, introduced a small tag with a price that was prominently placed on all his products.  A devout Christian, Wanamaker believed that if everyone was equal in the eyes of God, then everyone should receive equal pricing.  Besides winning him some points with the man upstairs, the price tag had the unintended consequence of speeding up the buying and selling process.  Other traders soon followed around the US and the price tag was born.

Since then, the price tag has become an established part of the buying process.  It’s hard to imagine purchasing anything without knowing the price upfront.  Even when the internet revolutionised and disrupted commerce for the better, the process of presenting a generic price remained.  Unchallenged and largely unnoticed.  The price tag has stayed ‘one size fits all’, even in a world of increasing personalisation.  It doesn’t matter who you are, what you purchased before, or what your income is, price typically doesn’t discriminate. But as a new business, how do you get your pricing right?

The first tip to getting your pricing right, is to really understand your numbers, and this is often the component that business owners shy away from. It’s time to get your calculator out. Take all your expected costs, starting with the Cost of goods sold (COGS), which refers to the direct costs of producing the goods sold by your business. Then add in any expected marketing, distribution or sales costs. If you are starting out, try to be conservative, as you usually end up spending more than you expect.

Let’s imagine you are starting a pizza restaurant. Let’s call it ‘Siracusa’.  To get started, you would add up the cost of your ingredients, rent, utilities, insurance, staff, cutlery and marketing. From this, you will have a mixture of fixed and variable costs. For a simple calculation, let’s assume utilities are fixed, in addition to rent, insurance, and marketing. You estimate that this will be $10,000 a month. Then your variable costs are ingredients and staff.  You can link these costs to sales. You work it out and estimate that buying 50 cans of tomato sauce, mushrooms, ham, 20 bags of cheese, and other ingredients, will allow you to make 100 pizzas, and these ingredients will cost $500. You average it out, that is $5 per pizza.

You then estimate that every hour, you will sell 20 pizzas, and you will need 1 staff at $20 per hour, for every 10 pizzas sold. You expect to sell 200 pizzas a night, and 40 pizzas per hour. So you will need 4 staff from 5 pm to 10 pm every night. Great, now, let’s get calculating!  

200 pizzas a night equates to $1,000 in ingredients. On top of this, you have 4 staff at $20 per hour for 5 hours a night. This equates to $400. So a total of $1,400 a night in costs. If you work this out for the month, it’s $42,000 in variable costs. Once you add the $10,000 in fixed costs, your total costs are $52,000 each month.  Don’t forget, this doesn’t include equipment, cutlery, cleaning and unexpected costs, so as a business you could easily be spending $70,000 a month just to keep everything running.

Now that you have your costs, you can start thinking about pricing. At a bare minimum, just to break even, you need to sell $70,000 a month in pizza. That’s a lot. Now, you need to consider your objectives, the market, and your competition. From an objective perspective, as a small business, you need to think about the salary you would like to earn and the amount of hours you want to work. For some business owners, flexible working hours is a great benefit of running a business, and they might be willing to sacrifice some earnings to hire an additional team member so they can work less hours each week.

Let’s imagine with Siracusa, you are happy being hands on, and would like a salary of $120,000 a year. So in addition to your $70,000 a month in costs, you add another $10k to be allocated for your salary. So your final total is $80,000 in expenses a month. It seems quite hefty but now we need to look at your revenue.

The best place to start is looking at your competitors, what are they changing, how are they rated, what type of service do they offer? A good tip is to even do some mystery shopping. Now if you honestly believe that your pizzas are significantly better, you can consider charging a higher amount, but it’s important you get some good early reviews. It’s important that your restaurant also has a premium feel and branding. There is no point having a no frills shop front and low end dining experience, if you want to charge a higher price for your pizza.

After your analysis, you determine that you think you can charge an average of $20 a pizza. Great, now let’s go and see what that means.  You go back to your forecast, and if you sell 200 pizzas a night, you will earn $4,000 a day or $28,000 a week. Over the course of the month, this equates to an average of $120,000 in revenue. This is great news, if your estimates hold true you will earn significantly more than your costs.  So you will have a healthy margin and profitable business.  The other good news is that if you only sell 135 pizzas a night, 65 less than your forecast, you will still make a small profit each month.

Now you can come back to your strategy. Because you have a number of competitors in your location, do you need to price aggressively to get customers to switch their loyalty.  Knowing that you have a potentially healthy margin to play with means you can try to offer some discounts when you launch, but is that a good thing? Do you want to cheapen your brand? Premium pricing can also mean that people can perceive your brand to be higher quality, whilst a cheaper price can indicate an inferior product.  So whilst you might achieve some short term sales, ultimately in the long run it might do more damage than good.

The good news is that with Thrive, you can track all your expenses and income instantly, and use this to decide on the best pricing strategy for your business.  Over time, as Thrive understands your business data, we will also allow you to compare prices with similar businesses in your industry or location. This can be used to help guide you on making better pricing changes that grow your revenue. Thrive also has budgeting tools so you can track your costs in detail and use this to decide on what spend can be cut.

Ultimately, it’s important that you look at your costs first to really figure out what your baseline prices will look like.  Then you need to start figuring out your strategy, objectives and competitor landscape.  When you pull everything together, and if you do the numbers correctly, it should be really clear what you need to charge to create a sustainable business model. If it’s not clear, then you either haven’t done enough analysis, or you need to go and adjust your costs or pricing strategy.  Getting your pricing wrong, can cause significant issues to your business, it might even be the difference between success and failure. Getting the price right however, will generally mean that your business will be right too!

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