The Price is Right or Is It
David Hinshelwood
Domestics
• Housekeeping – Fire, Toilets
• Timetable
Session Outline
• In order to look at pricing a service or a product we
shall look at:
• What are direct & indirect costs and how to calculate
them
• Costs for service based business
• Costs for a production based business
• Consider how much to charge?
• Different pricing strategies
• How do price and sales volumes interact?
• Leading to a process to work through
Session Outline – From this?
• Typical Decision Tree for Small/medium size business
• What’s My cost?
• Who are my competitors?
• What are their prices?
• What should my price be?
£3.00 per unit
list of known,
direct competitors
£7.50 per unit
£7.25 per unit
• Will that make me enough money to live?
Yes/No/Don’t Know!
Session Outline – To this?
The Price is Right – or is it?
Workshop delivered by
David Hinshelwood
Alternative Decision Tree
For small/medium size business
What’s my cost?
3.00 per unit
What’s my positioning strategy?
Top 25% price
Innovative design led
product
What are my long-term business
Objectives?
Build loyal niche
Who are other businesses competing
For same £’s spent?
What are their
prices/position/offering?
What are the obstacles to entering
my target market?
High – needs technical
specialist expertise
What is my sales price?
Cost
Long-term goals
Positioning
Strength of competitors
Product’s USPs
Obstacles to entry
)
)
)
)
)
)
£’s
Does that add up to viable business
Proposition?
Yes/No
What is Pricing?
• Pricing has to be low enough to attract
customers
• BUT
• High enough to make the business profitable
• Art or Science?
What is Pricing?
• Pricing is not a function of cost . . .
• It relates entirely to what the market will pay
Quote by Sir John Harvey Jones
• Price is:
– The value placed on what is exchanged
Positioning - Where you are relative to your competitors
Example for Teenage Fashion market
Price
H
Fat Face
Independent
Surf & leisure
Top Shop
Pri Mark
L
Desirability
H
8
Can be Complex
• Trains
– Peak
– Off Peak
– Super Off Peak
– Season Ticket
– Rail Cards
– Sales?
Setting the Price
• Must cover costs of production for the service
or product – (relatively straightforward?)
• Allow for a profit or surplus
• Place your product in relation to your
competitors charges
• How much is customer prepared to pay?
• Pricing has to be low enough to attract
customers
• High enough to make the business profitable
Setting the Price – a process
1. What is your cost?
2. What do you want to achieve – lots of low margin sales
or fewer higher margin (achievable?)
3. What are your competitors doing – who are they,
charges & pricing, indirect competitors?
4. What is your “value added” - quality, deliver on time,
more experience and expertise?
5. Choose your price –
1.
2.
3.
4.
5.
Above or below the competition?
By the hour or for a project?
Discounts for multiples?
Discounts for prompt payment?
Discount for distributors?
Direct or Variable Costs
• Direct / variable / revenue costs
• Goods and stock you use as part of the
business
– Vary with the amount of business carried out
Direct or Variable Costs
• Raw materials you need to carry out the business
– E.G. Jeweller would require gemstones, chains etc
– Furniture maker would require timber, glue, finishing
materials
– Hairdresser – treatment products
• Consultancy – stationery, printing costs
• Commission payments
– Agents
– Staff who earn commission as well as salary
– Auction fees
• Distribution costs
– Packing and delivery
Indirect or Overhead or Fixed Costs
• Indirect / overhead / fixed costs
• Regular expenses that relate to running the
business, rather than the service provision (even
if no business takes place!)
• Examples - Rent, Electricity, Insurance,
Transport, Stationary, Professional fees, Loan
repayments, etc. (and Drawings!)
• Not always easy to identify whether direct or
indirect
Costs
• If Service Sector
– The indirect costs will be high proportion of
the total costs
• If manufacturing
– The direct costs will be high proportion of the
total costs
Indirect or Direct Costs
You operate a hairdressers business.
Which category are:– Business rates
– Insurance
– Purchasing of Shampoo
– Rent
– Laundering of uniforms
– Motor expenses
– Advertising and marketing
– Weekend help – casual wages?
– Purchasing additional chairs for the salon
Gross Profit
Gross Profit
• Selling Price less direct costs involved in
making the product or delivering a service
• = “Gross Profit” or “Gross Margin”
– £’s – can be calculated as %
– Measure of business performance
– Comparable / benchmarking
• HMRC
• Banks
Gross Profit Values
• Example gross profit margins
•
•
•
•
•
Retail – 30% - 60%
Accountancy – 85% plus
Hospitality – 30% - 60%
Farming - 50% - 70%
Management consultants – 85% plus
Operating Profit
Operating Profit
• Gross Profit Minus the direct costs
Breakeven Point
• The point where income from sales exactly
equals all the costs incurred by the business
• Calculated by dividing the indirect costs for a
period (month / year) by the gross profit per unit
produced
• e.g. Desk manufacturer sells @ £300 per desk
• Direct costs = £50 per desk
• GPM £250 per desk
• Total indirect costs for the business = £30,000
• Breakeven point is £30,000 divided by £250
• = 120 desks per year / 10 per month
Contribution
• Product or Service sales achieved above direct
costs - the gross margin makes a contribution
towards the indirect costs of the business and
operating profit
• If a range of products or services compare the
gross profits generated by each to compare their
contribution
• Highest volume may not have highest
contribution
– But could be strategic - BOGOF!
Understanding Costs
• Work out all the costs to produce something
• Charge a price that is higher than the costs!
• = Profit!!
• But – not all black and white!
• Can you identify all the variable costs?
• And what are the fixed costs attributable to each product /
service?
Understanding Costs – Production led
• Direct costs for each unit
• Must have an estimate of number of units sold
• If only one product – divide total fixed costs by
the number of units produced
• Add direct and indirect costs together
Understanding Costs – Production led
• e.g. Desk manufacturer
• Makes 100 desks per year
• Direct costs per desk = £50 – timber, screws,
glue, varnish
• Total indirect costs = £30,000
• Indirect costs per desk = £30,000 / 100 = £300
per desk
• Total cost per desk = £50 + £300 = £350
Understanding Costs – Production led
Number of Desks made
100
150
200
Direct (variable) cost per desk
£50
£50
£50
Total indirect (overhead) costs
£30,000
£30,000
£30,000
Indirect Costs per Desk
£300
£200
£150
Total Cost to Produce a Desk
£350
£250
£200
Understanding Costs – Production led
• As the number of desks increases the cost per
desk produced will reduce
• Could sell at a lower price per desk?
• Could maintain the price and generate higher
profits?
Understanding Costs – Service
• Service business will need to calculate daily /
hourly cost
• Not all working hours chargeable
– Marketing / admin / holiday / illness etc
• Divide the annual indirect costs number of
productive days or hours
Understanding Costs – Service
• e.g. – photography business
• Total indirect costs £30,000 per year
• Allowing for holidays etc – able to charge for 200
days per year
• Cost per chargeable day = £30,000 divide by 200
days = £150 per day
• Add direct costs for a job (e.g. travel, printing) to
create selling price
Understanding Costs – Service
• Working 5 chargeable hours per day
• Hourly cost = £150 (day rate) divide by 5 hours =
£30 per hour
Cost Based Pricing
• Always determine the costs of producing and
delivering the product or service
• Take that cost of the product or service and add
a markup or profit
• Set a price that is high enough to cover the costsbut low enough to be competitive
Cost Based Pricing
• e.g. Photographer
• Hourly indirect costs = £30
• 1 day assignment, 7.5 hours, indirect cost total =
£30 x 7.5 = £225
• Direct costs – travel & print - - £40
• Total indirect and direct cost for this assignment
= £265
• “Profit” margin – say 20% = £53
• Total charge - £265 + £53 = £318?
Setting Prices
• e.g. Photographer
• However, Market Research indicates that locally
photographers are charging £500 per day
• ??
• What now – charge £500 or £400 or ??
• New start businesses – can be difficult to have
the market knowledge
Setting Prices
High
Low
Economy
Penetration
Skimming
Premium
PRICE
Low
High
Quality
PRICING STRATEGIES MATRIX
Premium Pricing
• A premium product or service to customers who
can afford it
• “It is the willingness of the customer to pay and is
the sum of the combined benefits that accrue to
the customer as a result of buying a given
offering”
• Consider if your business model is taking money
from those that can afford it
• E.g. Jimmy Choo, Mulberry
Economy Pricing
• If there is felt to be a need to offer value for
money for those that cannot afford high prices
• Need to be very cost conscious – keep to a
minimum
• e.g
– supermarket “basics”
»Primark
»Ryan Air – first seats (can sell add
ons)
Penetration Pricing
• Priced to gain market share
• Can be used to promote new products or
service's to gain market share – new starts
• Needs careful consideration to increase prices in
the future
• Must be very sure of costs and that the strategy
can be afforded – especially cash flow
• Good for businesses that have long-term goal to
be sold or businesses that want to discourage
competitors
Skimming Pricing
• Taking off the cream from the early market where
added value is at it greatest.
• Taking the most profit while you can
• Good for businesses operating in niches and
innovation
• e.g. band releases new C.D. at full price –
reduces price as sales slow down
Other Pricing thoughts
• Price Pointing – psychologically priced at £9.99,
59p, etc?
• Multi buy / volume discounts?
• Seasonal
• Captive pricing – e.g. utility standard supply
• Using car main dealership and getting
service carried out by the dealer
FACTORS TO CONSIDER WHEN PRICE SETTING
 Cost of Product/Service
 Competition – strength and numbers, i.e. supply and
demand
 Long-term positioning objectives
 Long-term business objectives
 Obstacles to entering your market
 Price Elasticity
Will Change in Price Effect Demand?
Decreasing or Increasing price can have a positive effect on
demand
The effect of a price change up or down depends on a
couple of factors which are known economic theories:
 Price Elasticity of Demand - % change in demand
%change in price
 J.N.D. – Just Noticeable Difference - % increase/decrease
applied to your product/service which market does not notice.
Reckoned to be around 5-7%. Meaning market may not notice price
increase, but won’t notice discount unless you make sure it is R.N.D.
– Really Noticeable Difference!
The impact of charging different prices for a
product or service
Selling Price (£)
45
50
55
Revenue from sales of 1,000 units
(£)
45,000
50,000
55,000
Direct (variable) costs (1,000
units) (£)
20,000
20,000
20,000
Gross Profit (£)
20,000
30,000
35,000
Indirect Costs (£)
25,000
25,000
25,000
Operating profit (£)
0
5,000
10,000
Pricing and profit
• At selling price £45 = breakeven point
• At £50 an operating profit
• At £55 an increase in profit of 100%!!
• The price set may impact on volumes sold
The impact of charging different prices
for a product or service
• Currently sell 100 units @ £100 per unit
• Direct costs are £20 per unit
• If increase sale price to £105, sales levels drop to
95 sold
• Should you sell at £100 or £105?
• 100 @ £80 = £8,000
• 95 @ £85 = £8,075
The impact of charging different prices for a
product or service
Selling Price (£)
45
50
55
Number of units sold
1,400
1,167
1,000
Revenue from sales (£)
63,000
58,350
55,000
Direct Costs (£)
28000
23,350
20,000
Gross Profit (£)
35,000
35,000
35,000
Setting Prices
• In the example has it has taken 40% more units
@ £10 less to achieve the same level of
profitability!!
Session Outline
• In order to look at pricing a service or a product we
shall look at:
• What are direct & indirect costs and how to calculate
them
• Costs for service based business
• Costs for a production based business
• Consider how much to charge?
• Different pricing strategies
• How do price and sales volumes interact?
• Leading to a process to work through
Workshop delivered by
David Hinshelwood
Alternative Decision Tree
For small/medium size business
What’s my cost?
3.00 per unit
What’s my positioning strategy?
Top 25% price
Innovative design led
product
What are my long-term business
Objectives?
Build loyal niche
Who are other businesses competing
For same £’s spent?
What are their
prices/position/offering?
What are the obstacles to entering
my target market?
High – needs technical
specialist expertise
What is my sales price?
Cost
Long-term goals
Positioning
Strength of competitors
Product’s USPs
Obstacles to entry
)
)
)
)
)
)
£’s
Does that add up to viable business
Proposition?
Yes/No
The Price is Right or Is It
David Hinshelwood