Your Pricing Is Probably Wrong

Posted by: Rod Kurtz on April 14, 2008

Your product is most likely priced wrong. The only way to know if it is priced right is to know the production and support costs and add on the profitability. This is called cost accounting.

Cost accounting is the messy story problem that most bookkeepers and accountants do not want to deal with. As chief executive officer, it’s your job to learn to do your own cost accounting. (There are plenty of used college texts available as well as Robert A. Cooke’s The McGraw-Hill 36-Hour Course in Finance for Nonfinancial Managers that I have all my clients read.) When you do your own cost accounting, you will know the heartbeat of your company. Your goal here is not to micromanage, but simply to know how much each unit of your product costs or each minute or hour of your service costs. How much money it costs you to make and sell one unit of goods or services is your cost-of-goods-sold plus your general, sales, and administrative costs. Remember to pay yourself a living wage, too.

Now you have the basis for setting your sales price. Knowing that you know the guts of your company will give investors greater confidence in you.

Marilyn J. Holt
CEO
Holt Capital
Seattle

Reader Comments

John Quillinan

April 14, 2008 5:13 PM

Companies that have matured at pricing their products have moved away from pure cost accounting principles of adding on a percent profit margin. Mature companies analyze the demand data to understand to set prices that maximize their profit. The optimal price is the one that maximizes your total profit (profit/unit x the total demand), not the profit per unit. It is often not just the price of one product, because the price of one product will affect the demand of related products (compliments and substitutes).

While I agree that you need to know the cost of your product, readers need to pull out their economics book and go back to price elasticity theory. But one should not stop there...basic price elasticity theory assumes "Cēterīs paribus", which translates into "with other things [being] the same" or "all other things being equal“. For example, "an increase in the price of beef will result, ceteris paribus, in less beef being sold to consumers." Putting aside the possibility that the prices of chicken, pork, fish and lamb simultaneously increased by even larger percentages, or that consumer incomes have also jumped sharply, or that CBS News has just announced that beef prevents AIDS, etc. -- an increase in the price of beef will result in less beef being sold to consumers. Ceteris paribus is fundamental to price elasticity theory. Unfortunately, there are a rare instances where everything else remains the same. Normalizing the demand data helps you satisfy the need for "ceteris paribus."
By knowing the drivers of demand for products, you can more accurately model the price-demand relationship for your products.

This is important for small as well as large companies. If you do not understand your market, then you probably shouldn't be in business.

Readers may want to trade "Finance for Nonfinancial Managers" for "Competing on Analytics" by Tom Davenport, and "Revenue management" by Bob Cross.

Michelle

April 22, 2008 11:37 AM

Knowledge about economics and cost accounting is very useful when it comes to finding the optimum price for your products. You also need an understanding about your customers and how your products fits their needs. A lot of things come into play for strategy. Pricing strategy is critical for long term profitability. Surely the goal is to maximize profits.

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