The launch of a product or service on the market requires knowledge so that the price charged is the most appropriate to the reality of the business and potential customers. In order to offer the best price on the market, it is possible to monitor competitors that are already installed and identify whether the price is compatible with the expected profit. It is important to be aware of the costs that the company will have to produce and make such a product available, since the unit price must be higher than the total costs and expenses.
In addition, it is necessary to differentiate them into fixed costs, such as those with rent and employees, and variable costs, which are directly linked to the business activity. In general, the selling price is defined by the sum of costs and expenses, including taxes, plus the profit you want to obtain:
Sales price = Costs + Expenses + Expected profit
Below we present the most appropriate ways to analyze and calculate the prices that can be charged for products or services.
How to calculate the sales price through Markup
The Markup concept is what makes it possible to calculate the sales price for the business, since it makes it possible to know what prices the entrepreneur may charge.
To calculate the Markup index of the business, it is necessary to have knowledge of fixed and variable expenses, and the level of profit that one wishes to achieve. These values can be arranged in an Excel spreadsheet for easy calculation.
The Markup results in a value that can be used as a percentage multiplier or divider, to be applied to the costs of acquiring or producing a well. For this, the formula can be used:
MARKUP = 1 / (1 – (DF% + DV% + ML%))
- DF: proportion in fixed expenses, such as employee salaries, rent, loan payments, etc;
- DV: percentage of variable expenses, which are costs that vary as more quantity is produced, as is the case with some taxes;
- ML: desired profit margin for the business. The higher, the more profit you will have when you reach the sales level.
This value that results from the index, can be multiplied in the cost of acquiring the goods, providing a service or producing, which are values that do not appear in the calculation of the index.
Markup calculation example
For a company that has a fixed expenses ratio of 18%, variable expenses, including taxes, at 28%, and an expected profit margin of 30%:
MARKUP = 1 / (1 – (0.3 + 0.28 + 0.18)) = 1 / 0.24
MARKUP = 4.10
If this deal involves the resale of merchandise with a cost of US $ 40.00, its resale price may be US $ 164.00, since 4.10 x US $ 40.00.
If the price is high for the market level, the margin is likely to be reduced, which also reduces the price charged.
How to calculate the selling price by contribution margin
The contribution margin can be used to define the unit selling price, for each commodity, by relating only variable costs and expenses to the value.
For the contribution margin, it is only necessary to consider the variable costs, which are directly linked to the product, and form the price from the expected revenues from each sale:
Contribution margin = Revenue at the price charged – (Variable Costs and Expenses)
The contribution margin can be calculated in percentage values, indicating the proportion of revenue when discounting variable costs and expenses:
MC (%) = Contribution margin / Price
The proportions in contribution and cost margins is what results in the price charged, so the price can be interpreted in several ways, carrying out the opposite process:
Price = MC (%) + Variable costs and expenses (%)
Example of calculation of contribution margin
For a product purchased for a unit price of US $ 50.00, with a 10% tax rate, that is, in the amount of US $ 5.00, plus other variable costs that reach US $ 7.50, we have :
Variable costs and expenses per unit: 50.00 + 5.00 + 7.50 = US $ 62.50
Therefore, if the price charged is US $ 110.00, the contribution margin of the product has the value of:
Contribution margin: 110.00 – 62.50 = US $ 47.50
For this price, a margin of 43.18% is calculated, that is, the percentage of revenue on variable costs and expenses in this scenario. If the price is higher, the margin changes, and its percentage also increases.
To define a fixed proportion of contribution margin, it is necessary to consider the remaining proportion that make up the costs. For example, if the margin is to be 60%, the costs must be 40%, which together, form the selling price.
|Price (Revenue)||US $ 156.25||100%|
|Variable costs and expenses||US $ 62.50||40%|
|Contribution margin||US $ 93.75||60%|
The sale price is responsible for the total proportion, since they include the costs and the margin expected by the dealer.
As the costs are US $ 62.50 per product, at a proportion fixed at 40%, the margin calculated with the remaining 60% must be US $ 93.75, which can be found in a simple “rule of three”.
Setting the price by market research
If a business is involved in a market with several competitors, it is necessary to analyze the prices that are charged by them.
In case the market projects a price well below what can be charged, the profit margin will be reduced as to what would be expected, or even below costs, making the project unfeasible.
For an activity in which costs are reduced, entering a competitive market can be advantageous since it may be possible to reduce prices and carry out promotions that attract more customers.
In addition, monitoring price levels in the market is essential to start activities and also to keep the business at the most ideal level possible.