Pricing made easy

Pricing is a key part of following any of our guides. It drives what businesses choose to do, including yours! So, it is an important concept that every business leader must understand.

As you follow this guide, you'll find out the basics of pricing your items and making money!

Step 1: Know your costs

All businesses require an investment, which is your money. As an easy example, let's take a look at what goes on when you run a lemonade stand.

There are two types of costs, fixed and variable.

Fixed (one-time) Costs
These are the one-time purchases that will last you throughout your business, like a glass pitcher to store the lemonade, a table, and signs to mark the stand. No matter how much lemonade you produce, you won't have to buy more of these items.

Variable (repeated) Costs
These are the repeated purchases you'll make to produce your product. In the lemonade example, this would be the lemons, water, ice, cups, and other items you'll have to buy again to sell more. These are really important when thinking about how much to ask for when you sell. For example, if it costs you $1 to make a glass of lemonade that you sell for $0.50, you lose 50 cents every time you make a sale!

Step 2: Setting a good price

Now, the next step to understand basic pricing is determining how much your product should cost your customers. Let's take a look at two commonly used methods to do this!

Competition-based pricing (easy)
To use this method for a lemonade stand, or many simple businesses, all you need to do is search up how much other people charge their customers. Go off what you see to set your price!

Cost-based pricing (more challenging!)
In this pricing method, you look at how much you're spending to make the product to set the price. For one person running a lemonade stand and other very small businesses, estimating your spending is accurate enough.

Think about how much it will cost you to make a the product. For our lemonade example, a glass of lemonade usually requires a lemon, water, some sugar, and ice. In total, it should cost around a dollar to make every glass. I'll go into more detail in calculating costs when covering break-even with variable costs. I'll use a simple formula to break it down clearly.

So, after determining costs, you want to set the price. You want to set the price higher than how much it costs you. For a lemonade stand, it's a good idea to add a dollar or two to the total cost to make a profit. So, in our example, we will sell our lemonade for $2.

Step 3: Determine your "break-even" point

Good businesses are able to make money. However, to run a business, you need to spend money at the beginning for the equipment. So, to determine if a business is worth starting, you should look at how much you will need to sell to make your money back.

You could think of it like a balance scale, where your spendings to run the business are on one side and the money it makes are on the other. The break-even point is when the two sides are equal.

Dealing with only fixed costs
Let's say you buy a digital camera to run a photography business. Because your cost per additional photo taken is around zero, you do not have variable costs. In situations like this where you only have fixed costs, you can find your break even point with the following method:

1. Determine your costs:
   $400 camera, $20 SD card, $150 lens.
   Total cost: 400 + 20 + 150 = $570.
2. Choose a selling price (to make money!):
   $5 per photo.
3. Divide the costs by the selling price to get how many you need to sell:
   $570 cost divided by $5 per photo
   114 photos needed to break even (and profit!).

Introducing variable costs
Now, this is where it gets a little more complex because your costs are changing. To do this, we'll have to use Algebra to introduce new variables. I'll go back to the lemonade stand example to explain this concept.

1. Separate your fixed and variable costs
   Fixed costs: $15 glass pitcher, $40 table, $5 for a sign
   Total fixed costs: 15 + 40 + 5 = $60
   Variable costs: $1 per lemon, $0.10 per cup (let's say water and ice are free)
   Total variable costs: 1 + 0.10 = $1.1 per lemonade sold
2. Choose a selling price
   $2 per lemonade
3. Multiply the variable costs by x (representing units of lemonade), add the fixed costs, and set it equal to the selling price multiplied by x:
   1.1 (variable costs) * x + 60 (fixed costs) = 2 (selling price) * x
   1.1x + 60 = 2x
4. Solve for x (to find how many units you need!)
   60 = 0.9x (0.9 represents your profit per cup)
   x = 67 units of lemonade (rounded up)

So, now you have an idea of how pricing in business works. This article should have taught you how to set your prices, and how to use these numbers to figure out how much you have to sell to make a profit.

Go launch your business!