How to calculate the prices of your products or services
“When you make a mistake in calculating your prices, you risk your reputation or your profit.”
One topic that often concerns many entrepreneurs is how to properly calculate the price at which they will offer their products or services in the market. As a fundamental element for the economic success of your business, there is often a great lack of awareness about all the implications involved in this calculation.
The price of your product or service, in addition to having a direct impact on your business finances, also affects your image and your positioning in relation to the competition.
A price that is too high compared to the competition may generate resistance among potential customers—unless it comes with a clearly superior value proposition.
A price that is too low compared to the competition may create the perception of lower value and discourage trials and preference.
Your prices must adequately cover your costs and also generate a profit margin. Otherwise, they jeopardize the viability and sustainability of your business.
How to calculate your prices?
In short, properly calculating your prices is vital and essential for the success of your business—both from an economic standpoint and in terms of building your brand image.
I don’t come from a financial or accounting background, but I’ve had to create multiple budgets and cost calculations for many different projects and products throughout my professional life. So, with great humility, I’m sharing some elements to take into account—compiled from my own experience and from reviewing and analyzing expert sources, which I’ll share at the end of this article.
Basically, your price includes two elements:
All of your costs, and
A profit margin
Sounds simple, right?
So why is it sometimes so complicated to calculate your price?
Because cost calculation involves many variables. And if you leave some out, your cost will be inaccurate—and therefore, your price won’t be appropriate either.
What should you include in your costs?
The idea is that each unit of product or service you offer should incorporate, in some proportion, ALL the costs you incur. Here’s a list of the things you should consider. Of course, depending on your business, some of these costs may not be relevant or may not apply. Once you go through the full list, you’ll be able to determine what applies to your specific case:
Raw Materials: All the materials and supplies you need to acquire in order to manufacture the product or provide the service your business offers.
Consumable office supplies.
Fixed operating costs of your office space (or workshop, or whatever space you dedicate to your business), which you must cover regardless of whether or not you produce the product or service.
Labor costs for the personnel you hire to work in your business, including all legal obligations such as social security contributions or any other mandatory payments required by law in your country. This includes your own salary. While it may seem obvious, you’d be surprised how many entrepreneurs I’ve seen who don’t include their own salary in the cost.
All professional services you require to deliver your product or service.
Marketing, sales, advertising, and distribution costs.
Travel and transportation expenses you may incur.
Financial expenses.
Other expenses.
Unexpected costs.
This list includes the most common elements that, generally speaking, apply in one way or another to almost any business. However, not all of them may apply in your case—or you may have additional, industry-specific costs that aren't listed here. In any case, it’s extremely important to break down in detail each and every expense you incur. Anything left out simply won’t be reflected in your pricing and, as a result, it will be absorbed by your profit—which will shrink in proportion to how many elements you omit in your cost calculation.
You can download from the links below an Excel template that will help you calculate your prices. This template is fully adaptable to your currency, your product or service, and your specific needs. You can also download a PDF tutorial that explains step by step how to use it.
Profit Margin
Once you’ve calculated all your costs and broken them down to the unit cost, you should then apply your profit margin. Here, you’re free to apply the margin you consider appropriate for your product or service and that is typical or standard in your industry.
Some sectors operate with a 30% margin, others with 20%, and some with just 5%. There’s no right or wrong here—you simply need to research your market prices, analyze your competitors’ margins, and test different scenarios until you find the one that best suits your sector and yields profits.
Price Benchmarking
You’ve calculated your price. However, the process isn’t over yet. This price would be, so to speak, the “ideal” price—one that covers all your costs and generates your desired profit margin.
Now comes the analysis and review stage. It’s time to fine-tune and determine whether the price you’ve reached is appropriate for your product or service unit, based on the current market offer and your competitors. This process of analysis and comparison with your market’s standard is known as benchmarking.
Is your price lower than your competitors’?
If so, check whether you’ve left out any costs. Assess the value of your offer and determine whether your competitors are offering additional benefits you are not, which could justify their higher price. If your value offer is equal to (or better than) that of your competitors and you’ve included all your costs, you might consider increasing your margin to raise your price. You can also decide to maintain a lower price and turn it into a competitive advantage—but always keep in mind the risk of hurting your brand image.
Is your price higher than your competitors’?
If so, assess whether your value offer is superior—are you providing different and better benefits that justify a premium price? If not, review your costs and see if there’s a way to reduce your unit cost without sacrificing quality. You could make your process more efficient to produce more units per month, which would lower the fixed cost per unit. You might also find alternative suppliers who offer the same quality at a lower price. If those adjustments don’t work, consider revising your profit margin to see if you can lower the price to a more competitive level.
Is your price similar to that of your competitors?
In this case, also validate whether your value offer is comparable. If your offer provides greater value, you could raise your price. If it provides less, consider improving your offer or lowering your price accordingly.
In any case, whatever your decision may be, it’s important to make sure of four things:
You are covering ALL your costs
You have a profit margin appropriate for your market and business expectations
Your unit price makes sense in your market, relative to your competition
Your product or service’s value offer is consistent with the price you’ve defined
You can download from the links below an Excel template that will help you calculate your prices. This template is fully adaptable to your currency, your product or service, and your specific needs. You can also download a PDF tutorial that explains step by step how to use it.
I hope these general guidelines are useful to you. As I mentioned earlier, this input comes from my hands-on experience, not from professional training—so I know there may be some omissions. What other factors do you consider that I haven’t listed? Send me an email at celia@celiasoonets.com so I can include them in future updates of the template.