Selling Price

To calculate the price of a product or service may be more complicated than it may seem at first glance. Let’s say, for instance, that the material you must be buy to provide a product or service cost $100. You want to make a profit of 20%, and therefore price the product at $120 (cost to manufacture the product plus the 20% mark-up).

Chances are that, if you do it in this way, you will find your company in financial difficulties soon, because of the multiple of “hidden” costs you have not considered, including:

– Personnel cost (even if you have no employees, you must still consider the “salary” to expect for yourself from the transaction)

– Taxes will bite into your profits, even though inputs costs can (in most taxation systems) be deducted.

– If you company has divisions and sections that support the manufacturing (such as Marketing, HR and/or Finance) they will consume costs that will not be captured in the cost of the raw materials you are using in the manufacturing process.

– Transport, logistic and warehouse (storage) costs.

– Municipal and other statutory costs.

In order to make sure that you properly account for all costs when determining the price of products or services, it may be useful to conduct a value chain analysis. The principle is as follows:

When a company introduce a new product, the development and delivery thereof go through several stages. You will do research and development (leading to the development of the product). You will do market research (and testing) to determine whether there is a demand for the product. If there are, you will introduce the product (or service) to the market.

All product and services go through life cycles stage; it is introduced, experience sales’ growth, maturity and then decline. You incur costs throughout all these stages, and want to make sure that the most profitable stages in the life cycle make good for the least profitable periods.

Costs to be considered when determining selling price will therefore need to include direct cost, indirect cost and overheads.

– Direct cost are the costs that can be attributed directly to the manufacturing of the specific product or service.

– Indirect cost are the costs that can be attributed to the manufacturing of a number of products or services (such as the purchasing price of, or the maintenance cost related to) machinery and equipment used to produce a number of product or services.

– Overhead cost is the cost incurred to maintain the infrastructure and functions that enable the production of goods and services; such as the remuneration of top managers, whose efforts cannot be attributed to the production of a specific product or service, and municipal bills.

However, there are more to consider; including fixed versus variable cost. Fixed cost does not vary according to the quantities produced, while variable cost does. The cost incurred as a result of the machinery purchased to manufacture a specific product or service, and do not vary according to the number (quantities) produced) is fixed cost. Variable cost vary according to the number (quantities) of the product produced. Raw material use in the manufacturing process is an example of variable costs; the more units the company produces, the higher the cost will be.

Remember, to determine the selling price of one product or service, we need to relate all costs (including direct, - indirect, - and overhead costs; as well as fixed – and variable costs) to unit cost (that is the cost incurred to produce one unit of the product or service).

Moreover, it is important not to forget about the costs incurred during the research and development phases of product (or service) design. If the decision-makers does not consider such costs, purchasing prices will bring in enough cash flows to maintain on-going production (and selling) of products and services, while the “hidden” costs unaccounted for will eat away on the ability of the company to sustain itself.

The decision-makers wants to know over which period the investment will be made, in order to calculate a price that will enable the company to recover the initial investment, as well as future costs incurred to produce the product and service and get it to the market.

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