How to Calculate Selling Price the Right Way
One of the hardest things to get right in any business:
How to calculate the selling price for your products.
Are you undervaluing your goods? Or way overpricing them?
Failing to get your pricing right can lose your customers and conversions on your e-commerce site. It is also a huge opportunity cost as you search for answers while developing your business.
In this article, we’ll be looking into the butter king and why you should all be hailing him!
What is Selling Price?
The selling price, be that of a product or service, is the final price the customer or client pays.
It’s extremely important to offer the correct selling price because if you don’t make a profit while also securing a position in the market, your business will not survive.
In short, successfully answering the question of how to calculate selling price is a win-win for you and your customer:
For direct-to-consumer brands, there’s a chance you can charge more if your brand image is in high demand like many clothing brands do, such as Adidas or Nike, but you’ll need a strong portfolio to back up your prices or a ridiculously strong marketing campaign.
What is Average Selling Price?
The average selling price (or ASP for short) is the price you charge your clients for your goods or service.
So, regardless of if you sell an item with 10 SKU variants or 100, you calculate the ASP by looking at the total revenue earned from those sales and divide the amount by the total number of units sold.
It's critical to calculate your average selling price as it allows you to monitor trends and make predictions on the marketplace. If you're a start-up manufacturer, it can be a great way to determine a pricing strategy.
How to Calculate Selling Price Formula
To cut a long story short, you’re always aiming to make a profit. Otherwise, your business won’t grow.
Now, the long version.
As a manufacturer, to calculate your selling price, you’re going to need to first calculate your cost price, otherwise known as manufacturing costs, using this formula:
Let’s say the cost price of an item is $50. The short answer is you need to charge more than this figure to make a profit. However, a rule of thumb is to add a 25% mark-up - a technique known as cost-plus or mark-up pricing.
Your selling price formula will look something like this:
In this case, the selling price would be $62.50. However, you need to consider other factors, such as:
- Competitors prices;
- Are you selling premium or value products; and
- Your marketing tactics.
Types of Selling Price Calculations
- Planned Profit Pricing
- What the Market Will Bear (WTMWB)
- Gross Profit Margin Target (GPMT)
- Most Significant Digit Pricing
Planned profit pricing combines your cost per unit with projected output for your business. You can use it to work out if your business will be profitable at your current pricing strategy. If not, you can increase prices or increase output.
The flexibility makes it suitable for manufacturing businesses.
This pricing charges the maximum (or very close to the maximum) for what the market allows. If an object costs $100 to manufacture, and the most a customer will pay for it is $500 — this is the market limit. This is a pricing strategy that can lead to very high-profit margins.
But beware – this is not a sustainable strategy - charging at the upper limits of what the market can bear leaves the field open for a wily competitor to undercut your prices easily. In short, it leaves you vulnerable to your competitors’ pricing strategy.
After you know how to calculate the selling price of a unit, you can work out the GPMT of your business. Say a company has $10,000 in revenue and the COGS is $6,000.
$10,000 minus $6,000 leaves you with $4,000 gross profit.
Dividing this with the original $10,000 leaves you with a gross profit margin of 0.4. Many manufacturing businesses aim for a GPMT of at least 20%, but this depends on your industry and costs.
You can use this metric to analyze progress to your ideal gross profit margin and adjust your pricing strategy accordingly.
Gross Profit = Total Revenue – Cost of Goods Sold Gross Profit Margin = Gross Profit / Revenue
This is why a retailer is more likely to price a product at $19.99 rather than $20.00. Customers are more likely to make a purchase when it is $19.99 because our brains tell us:
Other industries tend to use this technique, such as those in real estate. You can try it yourself. Take the previous price of $62.50. Would $59.95 be the more enticing price that leads to higher profits?
How to Find the Best Pricing Strategy
If your pricing strategy and your competitor’s pricing strategy are the same then it’s like missing out on utilizing a useful tool.
Like it or not, customers infer a lot of information about your business from your prices.
Another thing: the results of price changes are not always linear. For example, a company could raise its prices by 1% and see overall profits increase by far more than that, even if demand remained the same.
The best strategy you can apply is a flexible one.
Cost-plus pricing is how to calculate selling price per unit, whereas GPMT helps you decide if this approach can scale up.
Once you come up with a suitable price you can apply Most Significant Digit Pricing.
Commit to changing your price for a set minimum time and stick to that plan. Don’t keep changing prices, as this could reduce your customers’ trust in you.
Pricing Strategy Case Study
Let’s use the example of furniture manufacturers to illustrate the steps to finding a pricing strategy.
You know your manufacturing costs and resources spent, but is this enough to add a markup and call it a day? No.
Pricing is contingent on the current state of the marketplace and where your products fit into it.
First, you need to understand your market. Do all the research you can on the criteria of furniture pricing. These could be:
- Direct-to-consumer prices;
- Wholesale prices;
- Consignment prices; and
- Any area that deals with selling furniture.
You need to figure out how your product fits into the current landscape.
It’s good to set a minimum price that you will not go below. If you think of boundaries like this, it helps you think clearly in the stressful tasks of pricing and negotiation.
Don’t undersell yourself or go below your minimum price.
Pricing Strategy Quickfire Tips
- Have a Strategy, and Stick to it;
- Use pricing analytics to record market trends and predict future market changes;
- Look at the whole picture, not just on a transaction-by-transaction basis;
- Adopt a value-based approach to customer satisfaction; and
- Don’t use a one-size-fits-all approach to pricing. Be adaptable. Create pricing plans and product variations for customers with different needs.
Combine a Great Selling Price Strategy with the Best Production Software
Now you know why finding the right pricing strategy for your business is so important, you need to invest the time to do your business justice.
However, performing audits, even regular ones, can slow down your business or even reveal that you’ve been pricing your items incorrectly.
The best solution to determining your selling price is to adopt an ERP system with real-time monitoring and automatic cost price calculations, such as Katana.
Katana helps manufacturers take control over their production and inventory but also automatically calculates manufacturing costs too by looking into:
- Your material costs; and
- Production operation costs.
This will allow you to quickly get a better overview of your costs and make better decisions on pricing your products.
You can check out the video below for a better understanding of how to track costs of materials and products in Katana: