Pricing Products for Profit
Updated: 2 days ago
Owning a business can be extremely stressful. It sometimes can feel like there aren't enough hours in the day to go through an inbox full of emails, let alone worrying about the nitty-gritty aspects of your business. Whether you are fulfilling a need or trying to solve a common problem for your consumer, it is vital to make sure you make enough money to sustain yourself while reasonably pricing the product you are providing. Finding this middle ground will be the key to running a successful e-commerce shop.
Price of item- (COGS (Cost of Goods Sold)+ Costs for Marketplace + Transaction fees + Costs for Shipping (if offering free shipping) + packaging)= Net Profit
Definition of COGS: "Cost of goods sold (COGS) is the carrying value of goods sold during a particular period. Costs are associated with particular goods using several formulas, including specific identification, first-in-first-out (FIFO), or Average Cost. Costs include all purchases, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. Costs of goods made by the businesses include material, labor, and allocated overhead. The costs of those goods, which are not yet sold, are deferred as costs of inventory until the inventory is sold or written down in value."
There are a few different ways to apply the above. Here is an example if you were offering free shipping:
30 sales price
-15 cost of goods
-0.20 marketplace cost
-1.06 transaction fees
-2.00 warehouse space cost
-5.00 free shipping
$4.74 net profit
Now to Calculate Profit Margin (%)
$30 =.158*100= 15.8% profit margin
Note that 15.8% is a reasonably good profit margin. 10% is average, 20% is considered excellent or high, and 5% is considered very low. Even though you may deem your profit margin average, look at your net profit value and ask yourself:
Are you selling enough profits to pay yourself, re-invest in your business, pay your employees?
Most businesses have a lot more costs than just the ones above. COGS are solely related to the product you are selling and do not include all additional parts of the business such as the lease (if not working from home), computers, wifi, or even coffee for the breakroom.
Knowing these costs makes it even more important to analyze if that net profit sustains your business. If it is not, then you have multiple ways to adjust your bottom line, including:
Increase your sales price;
Find cheaper ways to ship;
Find a more affordable way to make the product;
Pay for packaging in larger quantities to reduce the cost per package;
Use a cheaper marketplace to host your product;
Adding up all of your fixed business costs separate from your COGS, dividing that number by your net profit is a great way to determine how well your net profit can sustain your business.
Let's try another example:
$500 per month lease
$75 per month wifi
$100 average per month utilities
$100 office supplies per month
$500 per month health insurance for employees
$8000 per month salary costs
$9375 total costs per month
Costs per month/net profit per item= how many items you must sell
9375/4.74= 1,977.85 items sold for breaking even each month
Remember that these fixed costs above do not always account for how much it costs to acquire a customer. Are you acquiring new customers for every single purchase? Are you only getting sales through repeat customers?
Customer Acquisition Cost (CAC)= Total marketing spend (salaries, tools, ad budgets)/the number of customers won.
=$3.33 to acquire that customer
Take your CAC and subtract that from your net profits.
4.74-3.33= $1.41 per item sold
This number is significant. If every single consumer is new, then you need to re-adjust. How many items will you have to sell to break even each month? At the beginning of owning your business, every customer will be new. It is much easier to keep a customer than it is to get a new customer.
CRC is calculated annually, so to understand the monthly cost retention; you would divide the number you get by 12.
CRC= Cost of (customer success team + renewals/accounts management team + customer engagement and adoption systems + customer engagement and adopt strategies + professional services and training + customer marketing)
**this includes salary costs and subscription-based benefits you use, such as CRM's
Once you have acquired this number, then you divide it by your # of active customers.
CRC= $60,000 + $90,000 + $130,000 + $1,000 + $5,000
Annual CRC per customer = $286,000/ #of active customers
Annual CRC per customer= $286,000/ 12,000
Annual CRC per customer= $23.83
Monthly CRC per customer= $1.98
This number is essential because, as mentioned above, it is cheaper to retain a customer than it is to get a new customer. You should also fold this number into your retail pricing. If you are offering a 20% promotion for first-time customers and you know that this will pay off in the end, then you can take the hit to retain the new customer and earn more money in the long run.
Remember, this example is short-sighted.
You will have more than one product, and therefore, you will have to calculate more than one retail pricing. Many business owners make the mistake of assuming that pricing will work out based on the marketplace or competitor pricing. This assumption is not valid because every single company is different and has additional costs associated with them. The best way to calculate the price of your products is to work backward. First, add up the cost associated with running the business. Once you understand the costs associated with running your business, you can project your sales numbers. Working backward is the best way to keep costs low and retail pricing realistic. If you have to lower your items to attain those new customers, add them to your customer acquisition cost. Keeping track of and understanding the numbers as precisely as possible is the best way to keep the business open. Don't be surprised by your data, whether they are considered good or bad numbers.