# How to Perform Product Price Formation

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8801 Price formation for products is the process of setting the sales value of your products. In industries as well as in retail, this process must be done continuously, because there is a great influence of the costs in the price and, typically, great variations.

Specific features: The products, unlike the services, also depend on the cost of personnel and raw material. In some cases, the latter is even more relevant. In addition, productive processes usually involve large structures and machinery, costs that must be amortized and projected. In addition, there are still costs of different natures that must be properly categorized and prorated.

How to: The formation of selling price of products is very specific, since it involves not only the unitary calculation, but also some larger projections to amortize large investments. In addition, markets are often dominated by cost, meaning the price of the product is as low as the cost allows. In a didactic way, we can divide the process of how to calculate the selling price in 3 steps: Unitary Cost of Production, Projection of Point of Equilibrium and Competition.

## I) Unit Cost of Production

The first step when designing product pricing is to know the unit cost. To do this, one must be able to separate the direct costs and expenses from that particular production. Let's use a fictitious product to exemplify, the famous: SCREW.

Let's say that the screws are made with iron and they pass through the machines A and B. In the image above, we have a shortened version of what would be the unit cost of the screwdriver.

Iron: R \$ 0,20 | This value must be found by the price per kilo of iron divided by the quantity used in the production of a product. Hypothetically, the iron KG costs R \$ 1,00 and we use 200 grams. Therefore, \$ 0,20.

Labor: R \$ 20,00 | This calculation should be done by estimating the hours spent by the personnel involved and multiplying them by the cost of those hours. In this case, we use R \$ 10,00 / hour and 2 working hours.

Machine Cost A: R \$ 5,00 | We are taking into account that machine A is a direct cost (that is, this is the only product that uses this machine). Thus, the calculation made is a division of the monthly maintenance of the machine by the amount that it can produce from Screws. We use the following logic: R \$ 5.000,00 / maintenance month and manages to make 1.000 products. Thus, the unit cost is in R \$ 5,00.

Machine Cost B: R \$ 2,30 | In this machine, we consider that it is an indirect cost, since other products also use it. Therefore, we are considering that it only uses 50% of the machine and the apportionment will follow this logic. Being the monthly cost of the machine R \$ 4.600,00 / month and it also makes 1.000 products, the cost is in R \$ 4,60 per unit. Taking into account that the apportionment is 50% we reach the value of R \$ 2,30.

In conclusion, each screwdriver R\$ 27,50 to be produced and now we have to analyze its price through markup, which will form the contribution margin. This vision helps the company to always think of lowering costs in order to have a more competitive sales price.

## II) Projection of Point of Equilibrium

As mentioned earlier, there are usually high expenses in the acquisition of machinery and physical structure in the manufacture of products. Therefore, it is important to make a financial projection taking into account not only the variable costs (R \$ 27,50), but also fixed expenses and a projection of sales volume.

Fixed expenses: In this case, we suggest that not only typical elements such as rent, energy, wages, but also the amortization of the machines or other long-term costs as land financing be included in the fixed cost.

Sales projection: Another essential point is to make a sales estimate per month for the product. This should be done behind some market premises that will be handled in a future position.

Sale price: Finally, working with these variables will help to make different simulations with the price to arrive at a realistic return scenario with certain level of sales and price.

Briefly, the equilibrium point calculation can be understood with the explanation below. To perform the calculation, simply multiply the selling price (PV) you have already stipulated by the quantity of products you want to sell (Q). This will be equal to the fixed costs (CF) + the variable costs X quantity of products (CV.Q). See the formula below:
PV.Q = CF + (CV.Q)
If you sell a box of candy, see the example:

PV (R \$ 10); Q (what I want to know); CF (RNXXX); CV (R \$ 10)
10xQ = 10 + (5xQ)
10Q - 5Q = 10Q = 2

So you need to sell 2 products to stay in zero to zero. From there you get to make a profit. ## III) Competition

Finally, it should, as in the service price formation, perform a comparison with the competition to ensure that the stipulated value is within the market standards or at least consistent with the positioning of the business. This post has clarified how to price your product? Here at LUZ, we offer management tools for companies, including a Excel worksheet ready for product pricing!