Lesson 3: Pricing
It’s hard to put a price on success. It’s even harder to put a price on something you love to make and sell.
While it may be tempting to just give it away, we’ll show you the calculations and considerations you need to make informed decisions about pricing your products.
Pricing
Pricing Your Products
Pricing is both an art and a science. There is no magic formula out there, only tools to help guide you. There is a tendency for new businesses to go too low in their product pricing, believing that it will increase sales and that volume will make up for the razor-thin profit margin. It may, but it will also mean that you may have to work night and day to make the math work out. Conversely, if the price is too high, people may look but not buy, and worse, buy from your competitor.
Don’t fret too much. You can always experiment with your products and pricing mix. You may find that you can get higher prices at certain events or during certain times of the year, such as holidays. Or you may have to drop prices if a competitor is near you at a street fair and is selling similar items for less, even if they aren’t as good as yours.
And, of course, you may have to adjust to changes in the cost of ingredients, packaging, or gas prices. That said, you don’t want to get into the bad habit of changing prices at the slightest whim or market fluctuation. You need to remember that your products have value in the market beyond the cost of goods. You may not be the cheapest, but if you’re the best, you’ll never have to apologize.
Calculating true food costs
The first step in the process is to list every ingredient for each product. You may want to use a spreadsheet for this so you can see ingredients that are used in multiple products that can be bought in bulk so the cost can be spread out over multiple products. Don’t forget the things you may have on hand, such as spices, oils, etc., used to create the product. They all contribute to the actual cost of making an item.
Next, total the cost of all the ingredients for that product. Remember that this is just a snapshot as costs go up and down continually. You want to revisit this analysis often to make sure that the costs of ingredients aren’t creeping into your profit margin.
After running the initial calculations for each product, you should readily see which is the most expensive and which is the least costly to make. As you perfect your offerings, keep this in mind. Your personal favorite that’s time-consuming and has premium ingredients may not be your most profitable item. Or the most popular.
Before we go further, see if there are any substitutions you can make in your recipes that won’t compromise quality but may reduce costs. A penny here and a penny there can really add up as you become a volume operation.
Now you know what the product costs to make. The next step is to figure out what customers will be willing to pay for it and what profit you need to make a buck.
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Courses
Introduction
1. Cottage Food Basics
2. The Business Plan
3. Pricing
4. Marketing
5. Food Booths
6. Food Trucks
7. Pop-Ups
8. Brick & Mortar
9. Exit Strategy
Determining Markup
Once you know the true cost of every item you sell, you can turn to incorporating your indirect profit into the price. A common strategy is to calculate the markup on each item. This markup covers the indirect costs of your business: (utilities, equipment, federal taxes, supplies, accounting, salaries and benefits, etc.) plus your desired profit. It doesn’t include sales tax on any goods. Sales tax, if collected, occurs with each sale.
You may be surprised that most food markups in the retail restaurant world are in the 200% to 300% percent range. Your own markup is up to you and you may have to end up adjusting it as you begin to look at your business’ financials to see how well you are meeting your projections. If you aren’t covering costs and making a profit, you may need to either find ways to decrease the cost of making your product, increase market demand, or increase your prices incrementally to see what the market will bear.
Obviously, you want to sell a product for more than it costs to make. The markup is the ratio of the profit made to the cost paid. If you make something that costs $8 and sell it for $10, that’s a 25% markup. This markup needs to cover all your indirect costs and leave you with a profit.
Stay with us here.
Now that you know the markup definition remember that it is easy to confuse markup with profit margin. They are not the same. A profit margin is the ratio of profit to revenue. In the example above, the $2 of the $10 is the profit margin, which is 20%, not 25%.
Time for some math.
- Determine the cost of the product you’re selling. Let’s say it’s $4. This is the Cost Price.
- To find your gross profit, subtract this cost from what you sell the item for. In this example, you sell it for $6 (Selling Price), so your profit is $2.
- Divide this number by the cost of the product $2 ÷ $4 = .50.
- Turn this into a percentage: .50 x 100 = 50%.
- This is your markup, which needs to cover your indirect costs (overhead) and your profit that you can use to put back into building your business.
If you want to figure out what to sell something for that includes your costs and a known markup target, you can use this same formula with a slight change.
The formula for this would be Cost Price ($4) x Target Markup (50%) = $6.
Don’t we all wish we had paid more attention in algebra class?
Here’s one of many Markup Calculators online that may help you.