Beth Anne had a great episode on pricing that talked a lot about the psychology involved in pricing and the ways in which you can potentially increase sales. My spreadsheet-loving accountant personality just had to follow up with an episode on the nuts and bolts of pricing your products. So get out your excel spreadsheet, and lets get started!
There are 4 components to determine a price for your product: Direct Costs, Indirect Costs, Time Value, and Profit.
Direct costs are anything directly attributable to the creation of your product. All the materials that go into your masterpiece are direct costs. Direct costs also include special packaging you might use, a business card you include in each box, or an Etsy Listing Fee. These are just a few ideas of the direct costs you may have. Write down all the direct costs that go into each product you sell, and determine the cost of each of these elements. Be as accurate as you can and make sure you do not leave anything out.
Indirect costs cannot be directly assigned to any one item. These are the costs of running your business that are not part of production. An example of these costs are accounting software, rent, utilities, web hosting, or training. Make a list of all of these costs by month. Then divide that number by the average number of products your expect to sell that month. The result is the indirect cost that should be assigned to each product. If your indirect costs change over time, or if your average number of products changes, come back and re-evaluate your numbers.
The value of your time to create your product is the third component. What is your time worth as an artist, designer, or crafter? What is your skill level worth? Once you have an idea of what you believe your hourly rate should be, you need to determine how much time it takes to make each item. If you make each item one at a time, this is easy–just time yourself! The most efficient way to make items is in an assembly-line fashion, if possible. Here is an example: lets say it takes 3 steps to make your product. You can do Step 1 to 10 of your items in 1 hour, for Step 2, you can process 20 of your items in 1 hour, and in Step 3 you can only get through 5 items in an hour. If we break everything down into 10 unit increments than Step 1 is 1 hour, Step 2 is .5 hour, and Step 3 is 2 hours. So a total of 3.5 hours to get 10 of your items completed. If you want to get paid $20 per hour, then 3.5 x $20= $70 divided by the 10 products you made in that time means that for each item your time should be valued at $7. The point is, time yourself, what is the best way to get through your work? Determine exactly how long it takes to make one item, and how much you think your hourly rate should be.
The profit you want to make on each item can either be a percentage, or a dollar amount you add right in to the formula. Make sure you have room in your pricing for profit, otherwise your business will never be able to grow and expand. Without profits you will not have the cash flow to experiment with new products, buy in bulk, etc.
Here is an example of two formulas that might work for you:
(Time Value + Direct Costs + Indirect Costs)x1.1 = Wholesale x 2 = Retail
Time Value + Direct Costs + Indirect Costs + Profit = Wholesale x 2= Retail
Use these formulas to determine a fair price for your products, but also to determine how viable your business model is. When you add up all your costs, is the price you should charge according to the formulas astronomical? If so, maybe you should look into some cost cutting measures. You might want to rethink how you create your products. Or you may reevaluate your hourly rate.
Although these formulas are extremely helpful, they don't have to be followed to a T. Compare your suggested pricing to your competition and evaluate in light of what you bring to the table. Play around with your pricing a little, but watch and see how your changes affect sales. Maybe reducing a product from $41 to $39 will result in a much higher rate of sales and therefore, the $2 cut makes sense. Treat your pricing like an experiment by making small changes and then observing the results of your price tweaking.
Please leave me a comment and let me know if this made sense or if you have further questions!
P.S. If you're looking for some worksheets to help you price your products, our Brilliant Business Planner contains several product pricing worksheets to get you started pricing your products.