How To Use Cost Based Pricing To Attract Clients
Using cost based pricing to attract clients sounds like an oxymoron, how can working out profit margins and using formulas create an emotional reaction in your clients and get them to buy from you? Well the truth is that your price is so much more than the money you make from a sale. It talks about how you view your business, the level of value you can offer your clients and helps the client work out if you are the right person for them. In short it is another point of communication which needs as much consideration as your marketing and branding.
In a previous post we talked more about why getting the right price is important and also how to use the market to set your price. Cost based pricing sets the price of the produce or service based on all the costs the business will have to pay to produce the product or service and then adds the profit margin on top.
Write your cost list - make a list of all the costs you business faces to deliver the product or service.
You will have costs specific to each product or service sold (variable costs). The amount your the business spends on these will increase or decrease depending on how many units you sell. For example a business selling jewellery will have the variable cost of producing each unit of jewellery. If you are a service business an example variable cost could be the unit cost of a journal you send all your coaching clients to start them on their journey with you.
There will also be fixed costs which stay the same no matter how many units you sell, for example, insurance, phone bill and website hosting.
Working out your wages - You also need to include a cost figure for how much you are going to pay yourself (sometimes called your personal survival budget or wages). This will be a fixed cost and should cover the money you need to take from the business in order to survive.
Complete the cost based pricing table - Below I have taken you step by step through the calculation. I have included a simple example for a business selling fresh coffee to illustrate the process.
- Step 1 – In Section A write the name of the product or service. Most businesses will sell many products or services and you should do a separate cost based pricing calculation for each product or service
- Step 2 – In Section B you should write the number of units the calculation is based on. Sometimes it is difficult to break the costs into a single unit and it can help to calculate the costs for many units. In the example below I am calculating the costs for making 10 cups of coffee
- Step 3 – In Section C you should list all the variable costs that the business will face to deliver the product or service. Put each cost on a separate line and then write down the value for each cost in the column next to it
- Step 4 – In Section D add up all the variable costs for producing 10 cups of coffee
- Step 5 – I have based our calculation on 10 cups of coffee. Section E shows the cost for producing 1 cup of coffee. This is calculated by taking the Total Costs (section D) and dividing it by the number of units in Section B (E=D/B)
- Step 6 – In Section F write down the price for the product or service. This should be high enough to cover the business fixed costs, personal survival budget and some extra to act as profit. You can use the information you got from the market based pricing exercise to help direct this
- Step 7 – Section G shows the profit margin. This is the difference between the unit costs (E) and the price per unit (F), so profit margin = F–E
- Step 8 – In Section H work out the profit margin as a percentage (%) by dividing the profit margin (G) by the unit price (F) and multiplying by 100
To get a copy of the cost based pricing table with built in formulas to do the calculations for you, click here now.
How to use the information - You’ve gone to the effort of working through your cost based pricing for all your income streams, but now what?
- If you put the figures in and the price you have to set to cover your costs and get your desired profit margin is very high compared to your competitors you need to think about
Would your customers would be willing to pay the price?
Are you offering a better product or service to justify the higher price?
Could you decrease your variable or fixed costs?
- If the price is a lot lower than your competitors think about:
Have you included all your costs?
Are you offering a lower quality product or service?
Would your customers be worried about doing business with you because of the low price?
You can use the results of your market based pricing work to answer the questions above. The main thing to remember is that your profit margin needs to be healthy so you can absorb any changes in costs or demand.
What challenges do you face when calculating your cost based pricing? I would love to know, just comment below now.
Don’t forget to download your free cost based pricing spreadsheet
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