Tips for how to price your products
A window retailer checks in with Ask FSB for advice on deciding how much to charge for her wares.
(FORTUNE Small Business) -- Dear FSB: My company sells windows and doors. How can I calculate the markup I should have our salesmen aim for when pricing a job? Is there a formula you can use to calculate your gross profit?
- Linda Diaz, San Juan Capistrano, Calif.
Dear Linda: As a matter of accounting, businesses determine their gross profit by taking taking the total revenue they generate from selling a product and subtracting the cost of making that product (sometimes referred to as the "cost of goods"). Gross profit is often expressed as a percentage, which you arrive at by dividing your gross profit by your total sales. You can determine your company's net profit by taking the gross profit and subtracting your total expenses from that figure.
That said, there's no simple formula that will tell you what markup you should put on the products you sell. In fact, what you can charge for your goods may vary greatly depending on the region where you do business, the competition you face and the state of the overall economy. But be careful: finding the right price to charge for the goods and services your company sells could be the difference between success and financial ruin.
"Companies often underprice the market for their product," says Brooks Fenno of Sales Mark, a Boston consulting firm for small and midsized businesses. "If you're not careful, you can very quickly steer your company into insolvency."
So how do you determine the right price? The best way is to look at what your competitors are charging and what other services they're offering along with their goods, said Laura E. Willett, a longtime advisor to small business owners and now a senior lecturer in the finance department at Bentley College in Waltham, Mass.
"When you look at pricing, it's not just a multiple of your cost. It's what customers are willing to pay and the perceived quality of the goods. Customers will usually be willing to pay more if you have a better product than someone else," Willett said.
Fenno of Sales Mark agrees. "Companies that offer the best products and services at the highest price are the most successful. If you want to battle at the low end of the scale, you have to be very astute to survive," he said.
That means knowing your market inside out.
"As a small company starting out, [Diaz] has to be out in front gathering the market information as a would be buyer. She has to be involved in each of the sales, even if she's not doing the selling herself," he said.
Practices vary depending on where you are in the food chain. For example, it's not uncommon for manufacturers to mark up their finished goods by 100% or more. But if your company manufactures doors and windows, you still have to know what your competitors are charging for their doors and windows, and what markups your customers are charging their customers to understand how much leeway you have, Fenno said.
Business owners in competitive markets also need to find a way to distinguish the goods and services they offer from those of other, larger competitors, Willett and Fenno agree.
"The piece customers look for when they go to a small vendor is what value they add. Can you help people in some way - by doing measurements or doing something on the design end? You have to identify those things in your market that can distinguish you," Willett said.
Regardless of what competitors are offering, small business owners also have to pay close attention to their other costs, such as fuel for delivery trucks - and to the larger economy, which can play a big role when it comes to setting prices.
"If Linda is selling doors and windows for new construction, you've got a home market that's really down right now, so that might not be the best market in which to be pushing prices up. If there's a recession and people aren't borrowing to fix up their homes and aren't moving, there's not much you can do," Willett said.
The best advice in that situation, said Willett and Fenno, is not to try to price your way into profitability, but instead to control your costs, keep an eye on your cash flow and try to squeak through until the business climate improves.