What is Pricing and How to Calculate Selling Price?

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How to calculate the selling price
Excel Spreadsheets

What is pricing? It is a series of evaluative methods to define the price of a product or service. THE pricing must be made from the cost structure of the company, the competition and the user's perception of value. How to calculate the selling price is one of the most strategic challenges that exist in a company.

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See also: Complete Pricing Guide

What is Pricing and How to Calculate Selling Price?

Why do? Determine the price of a product ou reach the price formation of a service is an action that requires much care and research, because it depends on the success of your sales. The name given to this activity is pricing. An ill-priced product or service can lead the company to have very strong, perhaps definitive, collateral damage. She can sell less or can not pay her own bills for not contribution margin proper.

At this moment questions arise such as: is it possible to have a good profit without scaring the prospective buyers? What points should be considered when pricing my product or service? As pricing is a recurring question, we've come up with some tips for choosing your best pricing model.

Types of Sales Price Calculation

Cost-based pricing

This is the most used model in pricing, where all costs are surveyed and the markup percentage is added. In the service sector, the cost is directly related to the number of hours worked and the total number of employees involved in the service. In the case of industries the cost will be linked to the expenses with raw material, logistics and inventory.

Competitive price

In this model of sales price formation, the starting point is the existence of a competitor working with the same product or service, without major differentials. Therefore, in order to calculate the sales price, one takes into account the cost charged by the competition, but it is also possible to consider other expenses and thus to approximate the value of what is practiced in the market.

Price based on buyers' perception

In this type of pricing, one observes the value that the consumer perceives when acquiring the service. For this, it is important to evaluate what the acquisition of the product or service represents for the consumer. If he fails to spend the money he owns with other things that your product or service replaces. This is one of the most important pillars to learn how to calculate sale price.

To help you, try value curve. It will help you analyze whether your company has differentials in relation to the competition and if the public values ​​this product.

What is the best kind of sales price calculation?

In fact, in this case, it is not "either one or the other". You need to understand the three factors and validate if your price meets the three strands: cost, competition and value perception. I usually say that the goal of every manager in pricing is to generate more and more value to your product. In this way it will depend less and less on the competition to price and may have a more flexible cost structure.

Let's take a quick example. If a manager has a butcher shop, which is the same as all other butcher shops in the area, he can not charge much more than the other butcher shops. Therefore, the price of it will be hostage to the prices charged by the competition. Your cost structure will have to meet the price given by the market.

Now let's say he sought differentiation in his butcher's shop. He began working only with first-class meats imported from Uruguay and Argentina to serve the richest public in the region. The other butcher shops are no longer your competitors. Of course, he can not charge absurd values, outside the reality of the spending of families with food. But I can say with some degree of certainty that if your average ticket is twice the average butcher's shop, it will not be absurd.

He started to have more flexibility in pricing by working with a product that no one else works for and serving an audience that was not served before. Competition is no longer the crucial factor of your pricing and it may increase your cost structure to meet your differentiation.

How to calculate the selling price?

1. Evaluate direct costs

How to Calculate Sales Price - Direct Costs

Every product or service has direct costs, that is, those that depend on the end activity to occur. Let's take a quick example: if a company for its production, it will continue to pay rents but will no longer pay for inputs. In this case, inputs represent a direct cost, while rent represents a indirect cost.

In one factory, the direct costs are usually raw materials, non-fixed labor, and warehousing and logistics costs. In a trade, the purchase price of the products for resale is the main direct cost. In a service company, the labor costs associated with the services and travel expenses and materials required for the rendering are usually the main direct costs.

What is Pricing and How to Calculate Selling Price?

2. Set your desired margin

From your direct cost, you need to think about the margin you want to practice. Let's say your product has R $ 10 of direct unit costs with inputs, transportation and labor. You need a contribution margin to pay fixed expenses.

How to Calculate Selling Price - Fixed Costs

A lot of people ask me how to set the margin. There is no exact science that is not cost-based. The problem is that if your business does not have a cost structure the price will be out of the reality of the market. So what I recommend is that first you set a margin more according to the market, then evaluate if it is in line with the costs of the company. From there, adjust until you get the right price.

How to calculate sale price - markup - profit margin

We will apply actual R $ 20 margin to product price. Its preliminary price will be R $ 30. I'll move on to the next step for you to understand and then I come back to that concept. But all you need to understand right now is that the contribution margin is what is left over from the value of the product or service, after deducting the direct costs, to pay the fixed costs and generate the profit margin.

3. Calculate the Point of Equilibrium

To analyze whether the sales price calculation is within the company's reality, we need to calculate the breakeven. This is nothing more than the amount of sales that the company needs to make, to pay its fixed costs and go from zero to zero. Do you remember that I said that the contribution margin is what is left over to pay the fixed costs and form the profit margin? Yeah ... this is the time!

There is a problem in calculating the break-even point. Few companies have only one product or service. Therefore, before leaving for the calculation itself, the manager must define how much of the fixed costs the product or service in question must pay. For the sake of simplicity, I usually relate this portion to the percentage that the product occupies in sales. If it represents 30% of billing, it is expected to pay 30% of the accounts.

How to Calculate Selling Price - Break-Even

Returning to our example, our provisional price was R $ 30. Let's say this product represents 20% of sales and the company has R $ 100.000 of fixed costs per month. For the product to stay in zero to zero, that is, to arrive at the equilibrium point, we expect that its contribution margin will generate for the company at least R $ 20.000. To do this, the company will have to sell 20.000 / 20 = 1.000 units of the product.

If the sale of more than 1.000 units is according to the productive capacity, sales and delivery of the company, the price has just been validated from the point of view of cost. Otherwise, you will have to go back to the 2 point and rethink your margin. (I.e.

4. Evaluate if your price is in line with the market

As I said before, it's no use if the price of R $ 30 is validated from a cost point of view, if it is not market validated. In this case, the subjective analysis that must be done is:

  • Is the price within the reality of the competition (little above or slightly below)?
  • Are customers willing to pay this amount?

If the answer is yes to both questions, fine. Your final price is validated. Otherwise, the bad news is that you will have to make adjustments in your cost structure to be able to practice lower prices.

More Pricing Articles

If you are looking for articles more linked to your reality on the subject sales price formation, we have the right content for you:

Spreadsheets for Sales Price Calculation

Understanding how to calculate selling price is essential for any business and by following these steps you will find the right model to price your product, service or project. LUZ has developed a package with 7 pricing sheets and handout which is ideal for helping you at this stage of your business! Get this tool already and increase your sales!

What is Pricing and How to Calculate Selling Price?

Excel Spreadsheets

3 COMMENTS

  1. Hi Alexander, it all depends on how you organize your production. But overall, if you pay your employee monthly, you need to think about the calculation taking into account your break-even point. Let me give you an example.
    1 - Your burger's price is 10 and its cost (bread, meat, sauce, etc) is 5
    2 - This means that your contribution margin for each one sold is 5
    3 - Suppose your fixed costs, which include your employee's salary, rent, etc. are in 1000
    4 - Your break-even point is the fixed cost divided by the contribution margin, which in this case would be 1000 / 5 = 200
    5 - so if you just sold burger, you would have to sell 200 in the month to tie up revenue and expenses

    Now, you need to analyze if this price is enough, if you need to charge more, have other complementary products with bigger margin, etc.

  2. If I produce snacks (eg hamburger), my employee's workforce is fixed cost, right?
    But when it comes to pricing, how do I do it? Does it come as a variable cost? Thank you!

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