Pricing and Profitability
Many businesses believe that pricing is the most critical component of their new venture. It isn't. It is one of many. Without a clear identification of clients and competitors, pricing can be erroneously set and either repel clients or attract competitors.
A price is the amount or conditions required to consummate a transaction. If the price for a tube of toothpaste is $2.99, that's what you must pay to make it yours. If the price for a new car is $25,000 plus your old car, that's what it will cost you to complete the transaction. Some purchases have additional conditions, such as approval of a law, lender, or other authority. You cannot purchase alcohol, for example, unless you are of the legal age in your state.
It is critical that your business plan includes specifics on how you will price your services. Yes, your investors, if any, want to know your pricing structure; however, you also need to analyze and document it. Without appropriate pricing, your business may not be profitable. You need to establish pricing guidelines, make certain they are competitive, and make pricing easy to implement and easy to adjust if needed to meet changing business conditions.
Margins and Discounts
A margin is the measurement of a difference. In business, you'll be using price margins, gross margins, profit margins, and other margins. Pricing is the task of establishing a price difference between what you pay and what you charge for products and services. Gross margins and markups have an impact on pricing and profitability.
A gross margin is the amount of income left after paying for the goods sold. If your business sells $1,000 in services that cost you $600 to produce, the gross profit or margin is $400. It's more useful to calculate gross margin as a percentage of revenue. Simply deduct costs from sales, divide the result by sales, and convert it into a percent. Divide the gross margin of $400 by the sales of $1,000 to get 0.4, then state it as a percentage: 40 percent. In the example, the gross margin is 40 percent.
The price at which you sell your service has a big impact on your business's profitability. However, it isn't the only factor. Costs are critical, too. A cost is what you pay for something. It could be the employee costs required to provide a specific service or the wholesale cost products you will sell with your services.
In business, costs are typically segmented based on whether they are fixed or variable. A fixed cost is one that doesn't change in proportion to business activity. A retailer or manufacturer, for example, must pay rent, utility bills, and salaries regardless of whether sales levels are high or low. Fixed costs typically are not included in the costs of goods sold. A variable cost is one that does change in proportion to business activity. Typical variable costs for a business include the cost of goods sold, materials, and production costs.