Glenn MuskeRural and Agribusiness Enterprise Development Specialist

NDSU Extension Center for Community VitalityGlenn.Muske@ndsu.edu

Pricing:Is It Magic?

MORE INFORMATIONWebsite: www.ag.ndsu.edu/smallbusines

Facebook: www.facebook.com/NDSUextsmallbizTwitter: www.twitter.com/gmuske

Objectives• Understand the basics elements of pricing• Examine commonly used pricing formulas and

strategies• Develop an acceptable price range• Consider pricing as part of marketing

Psychology of Pricing• No “RIGHT” price• Perception – starts in the mind of the

buyer and seller– Compares price to value– Not always correct– Based on:

• Own experiences• What others tell us• What we believe is true

Typical Seller Expectations

1. Everyone will want one of these for that price

2. No one will pay that price

Seller Expectations Based On:– Self- esteem– Greed– Knowledge of the market place– Understanding of underlying costs– Knowledge of the value of your time– Goals for the business and personal life

• Monetary• Image

What’s Your Image??Wal-Mart or Neiman-Marcus

Remember:Buyer expectations set by

• Image• Brand• Advertising• Service• Store layout and upkeep• Actual product and service itself• Tangible and intangible

Price Sensitivity Issues• Price at

– $4.99– $18.95 (books)– $335/hr (services

• Big ticket vs. small ticket items• Time of year• Sale or the illusion thereof

Perception of Value• Appear at the lower end

– Gourmet food in a gift shop• Value-added• Appeal – school colors and/or logo• Name brand• Demand curve

Demand CurvesTypical Inverse

Price Price

Quantity Quantity

Pricing Challenges• Not under-estimate or over-estimate• Knowing the market• Recognizing the issues of value, prestige, and

quality• Knowing the competition• Understanding the basics

The Basics of Pricing

Is Pricing an “Art” or a “Science”?

The Basic Formulas

Profit= Revenue - Costs

Revenue = Price per unit x # Units sold

Pricing/Profit Myths

• Making money = Making a profit• Selling more units = Making a profit• Selling at a lower price = Making more profit• Selling at a higher price = Making more profit

Know Your Costs• Direct – materials, supplies, shipping, salaries/wages,

benefits, waste, etc

• Indirect – rent, utilities, salarie/wages, taxes, insurance, travel, advertising, marketing, utilities, transportation,

Time

• List all steps in producing a product or performing a service

• Time yourself (or whomever is doing that step) – Don’t Guess!!

• Put a value on that time– 1 general value or specific value for each type of

work– If a service, consider difficulty, special convenience

for customer, etc

Time

• Average work year = 2080 hrs/year– Allow for:

• Vacation• Sick days• Holidays• Administrative details• Non-productive time

Other Pricing Issues• Buying materials &

supplies at retail

• Replacement of capital items

• Taxes

• ROI

• Profit

Pricing Steps

Step 1From $0 to maximum a customer will pay Ceiling

$0

Acceptable

Step 2Floor – Set by basic costs Ceiling

$0

Acceptable

Floor

Step 3Don’t forget your salary Ceiling

$0

Acceptable

Floor

Salary

Step 4TAXES!! Ceiling

$0

Acceptable

Floor

Salary

Taxes

Step 5Make a profit – The first area where you

can negotiate – But don’t forget ROI, depreciation, etc.

Ceiling

$0

Acceptable

Floor

Salary

Taxes

Profit

3 Truths

1. You must sell at a profit over the long term if your business is to survive

2. Profit is not a 4-letter word

3. Consumers may or may not be very sensitive to price changes

Break-even Analysis

• The goal – Revenue ≥ Costs

What one piece of information is still missing?

Issue of Size (Scale)

1

500

5,000,000It gets cheaper, typically, the more you produce!

- May be certain breaks or price-points.

Pricing Formulas, Policies, and Strategies

Ask Yourself – How Much Money Do You Want to Make?

Hourly Wage Rate Formula

Desired annual net income

per year = hourly rate# of working hours

Classic Formulas

(Cost of labor + materials for one unitx # of units produced per year

+ estimated annual overhead = Wholesale cost+ desired annual profit)# of units produced per year

Retail cost = Wholesale cost x 3 (Keystone)

Formula Strategies Examples

1. (Materials x 3) + Labor

($2,930 x 3) + $3705 ÷ 245 = $51/unit

2. (Materials + Labor) x 3

$19,905 ÷ 245 = $81/unit

3. Materials + Labor + Overhead (30%) + Taxes

(10%) + Profit (10%)

($19,905 + $5,972 + $2,588 + $2,588) ÷ 245 = $127/item

Mark-Up

• On retail - % = Dollar markup/Retail price

• On cost - % = Dollar markup/Cost

Formulas are only a guide!

Suggested Pricing Policies

• Motivate large orders• Establish yourself in the market place

– Don’t under price• Lock in the customer (rebates)• Avoid price conflicts• Disguise price cuts• Don’t lower price without a signed order

More Pricing Policies

• Push high market products• Don’t want all customers• Don’t make money on price and then lose it

on terms• Find out what is common for your industry• Be always aware of the competition

Pricing Strategies• Maximize profit• Ensure adequate cash flow• Increase sales volume• Increase market share• Meet or beat competition• Create/maintain an image• Improve customer relations• Penetration pricing• Market skimming

Common Pricing Methods

• Value-added• Value - A “good deal”• Competitive• Cost-pricing• Multiplier pricing• Dart Board

The Big Unknown

Human Psychology

Summary

• Easiest method may not be the best• Future capital needs• Complementary products and services you might

sell• Don’t undercut your dealers• Don’t forget regular price adjustments• Remember to allow for waste, damage and mark-

downs• Build in money for attracting and retaining

customers

Summary

“After you do all this, throw it out the window and use common sense”

Anonymous entrepreneur

Raising ProfitsIt’s okay:• Cutting costs• Producing more for the same cost• Changing prices

– Difficult to raise prices– Be wary of price cuts– Perhaps give more value– Do not always reduce sales volume

It’s not okay • Cut your salary or your profit!!

Glenn MuskeRural and Agribusiness Enterprise Development Specialist

NDSU Extension Center for Community VitalityGlenn.Muske@ndsu.edu

Questions??

MORE INFORMATIONWebsite: www.ag.ndsu.edu/smallbusines

Facebook: www.facebook.com/NDSUextsmallbizTwitter: www.twitter.com/gmuske