March 1, 2003
Q: I want to start a business and I read that small businesses need to follow certain pricing formulas. Can you tell me what they are and whether they’re effective? If not, what’s factored in when determining costs?
–D. Rogers, San Jose, California
A: This is difficult to answer in a single column, but I’ll go over the basics. The first commonly used pricing formula takes the direct costs (the cost of the goods to you) and adds it to your overhead and the profit you’d like to make. The other (and simpler) formula is calculated simply by doubling the wholesale price.
However, neither of these formulas addresses things like whether the price you charge is tied to what consumers are willing to pay. Basically, how much you think your product is worth doesn’t matter if the consumer isn’t willing to buy it at that price. Then there’s the tendency of many consumers to equate price with quality. If the price is too low, they may be suspicious that they’re getting shoddy goods, but on the other hand, you don’t want to price yourself out of customers.
A good rule of thumb is to see what the competitors’ formulas are. Depending on the type of goods being sold, they might take the price and add a straight percentage or take the price and factor in shipping costs.
In short, I’d advise that you take time to evaluate all the factors that impact the price of your goods or services and check out the competition. For more detailed information, read The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making by Thomas T. Nagle and Reed Holden (Prentice Hall, $45.50). This book will go a long way in answering your questions.