Cost estimation is one of the steps in a pricing process. In other words, it is the financial and mathematical part, but it is not appropriate to set its price based solely on its costs.
See also: Complete Guide to Price Pricing
The Pricing Steps
In general, and this applies to any type of business, pricing has some ingredients:
- Survey and Cost Estimating: This, in fact, is only the first step. With it, the minimum price of the product is guaranteed, within a certain point of balance, so that the company does not have any loss in its sales.
- Point of Balance Analysis: The price you should practice will certainly vary according to the sales volume of that product or service. Therefore, pricing is always related to sales projection.
- Business Model Definition: The manner in which you intend to deliver and charge the product, affects its pricing, this should always be taken into account.
- Competition Analysis: Every business is embedded in a market full of internal forces and conflicts. For pricing properly, you have to understand what your competition is delivering for value and how it is charging for it.
- Positioning and Strategy: Finally, knowing all the above information, there is a part of the pricing that is purely strategic. That is, how do you want to be seen? What opportunities do you see and how will you translate them into your price?
If pricing as a whole interests you, be sure to read our post on pricing strategies.
Cost Estimating Example vs Pricing
Let's go through a practical pricing case to be clear, in numbers and in possible decisions, the difference between cost estimation and pricing. In this example, you make wooden furniture, especially benches.
Step 1: Cost Estimates
The first step would be to check the quantities of wood, nails and glue used in the production of each bank. In addition to this, you would also have to add the hour value of the professional involved in this development. In this case, you would have a result similar to the one below:
- Madeira Island: m2 in the amount of $ 30
- Nails: 16 from R $ 0,50 to Drive = R $ 8,00
- Tail: 1 / 3 from R $ 12,00 = R $ 4,00
- Marceneiro: 4 hours at R $ 20 / h = R $ 80,00
So your simplified cost estimate for your bank would be $ 122,00.
2 Step: Balance Point Analysis
In this next step, you want to check whether, within your fixed cost structure, and sales projection, your operation would be feasible. So let's add some variables.
- Fixed cost: R $ 5.000,00 (salary and rent)
- Sales projection: 30 banks per month
In this scenario, if you sell the 30 banks at the cost price, you could earn $ 3.660,00. That is, it would have a loss of R $ 1.340,00. To exit from zero to zero, that is, to really reach the minimum of your break-even point, the unit sale amount would have to be $ 166,70 (5000 / 30).
3: Business Model Definition
Here, for example, what we could change things would be big changes in the business model, that is, instead of simply selling the bank, you could:
- Rent the bank
- Auction the bank
- Change the price to encourage the bank's return
Anyway, we will not delve into this point, not to lose sight of the final result, but usually changes here is where the great revolutions in industries already outdated.
Step 4: Competition Analysis
Following, now that you have your cost estimate (R $ 122) and your minimum break even price (R $ 166,70), you go to see the price of the competition and have the following results:
- Competitor 1: R $ 399,00 (excellent product, new in the market)
- Competitor 2: R $ 99,00 (very low quality)
- Competitor 3: R $ 500,00 (reasonable product, best known company)
Again, you can see that your break-even value is not exactly where you want it, because its quality is excellent and you have already created a name in the market, you can value and charge for it.
5 Step: Positioning and Strategy
With all of the above information, you would see you reach the final stage of pricing that is rightfully part of mathematics and part experience, strategy, intuition and testing. By realizing that your product is the best and your reputation is significant, you resolve to adopt a premium pricing strategy and place your product as the most expensive on the market at R $ 800,00 per bank!
As you can see, in practice, the difference between the cost estimate is theoretically large and also mathematically. In our case, we left an estimate of R $ 122 for a final price of R $ 800! If you want to know more about how to raise your costs and get a correct pricing, see our spreadsheets for pricing.