Pricing For Profit - Step Two

Once you know how much the merchandise or job costs, you mark it up to provide a profit. One way is to use what’s known as “keystone” pricing, which simply means doubling the cost to arrive at the selling price. This provides a 50% gross profit margin. That’s why retailers can put goods on sale for 40% off and still make a profit. It works fine, but it isn’t always the best choice.

You can also use manufacturers’ suggested retail pricing, which even further simplifies the calculations. Nationally uniform prices, of course don’t reflect local market conditions, much less the individual business owner’s costs of doing business. Remember, too, that they’re designed to help the manufacturer move more merchandise, not necessarily help you make more money.

Using a standard markup sounds simple, but that’s really only the beginning of sound pricing strategy. You also have to be sure that the gross profit is large enough to cover your overhead, or the indirect costs of operating your business, and still leave a net profit. Whether you’re marking up merchandise or deciding on a labor rate, you’ve got to build in something to cover the rent—and all those other bills you pay every month.
Every business has indirect expenses (not related to the cost of a piece of merchandise or a particular employee’s labor on a job) that have to be paid. The obvious ones include your building and what it costs to operate it (utilities, maintenance, taxes, insurance), your fixtures, tools, office equipment, vehicles and other fixed assets (their cost on an annual basis is your depreciation expense), your salary and benefits (especially health insurance), not to mention the office manager and other general employees. Don’t forget to add in your property and casualty and liability insurance premiums, accountant’s fees, advertising and marketing expenses, office supplies, telephone, and so on and so on. While you’re at it, make sure you include an annual contribution to your own retirement plan, be it a 401-K, SEP-IRA, or whatever.

Finally, add something for net profit. That’s the whole point of running the business, right? The net profit, by the way, is not the same as your salary as the manager or owner. Your salary is payment for your labor managing the business. If you’re the owner, the net profit is the return on your investment and the compensation your receive for the risks you take. There’s a big difference.

The total dollar amount of your shop’s gross profit, the figure that has to be larger than your overhead expense, is also dependant on how much merchandise you sell or how many jobs you complete. These are determined, at least in part, by the prices you charge. If your prices are too high, customers will run away, so it can be a vicious circle. Cost-based pricing is all well and good, but ultimately, the prices you charge are determined by what your customers are willing to pay. That’s where a whole raft of other factors comes into play.

Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.

Pricing For Profit - Step One

When it comes to prices in your business, how much is enough and how much is too much? How do you set your prices? Buy low and sell high is the obvious answer, but for many companies, especially those with a mixture of retail merchandise and services, bricks-and-mortar and online competition, and customers driven one day by a penny-pinching budget and the next by the lust called gotta-have-whatever-at-any-price, there aren’t any easy answers.

Setting prices requires that even the most experienced manager or owner take a few moments every once in a while to dust off the calculator, get the accountant on the phone, and do some serious figuring. It’s tempting to just mark all merchandise up by a fixed percentage and figure labor at a flat rate comparable to what your competitors charge, but that’s not managing for profit, it’s hoping for one. There are several factors that you should consider.

Start with the cost of goods sold. That’s the amount you pay the manufacturer, wholesaler, or whomever for the merchandise you sell, whether at retail or as part of a service job. But it also includes the cost of acquiring those goods (shipping and handling), carrying them in inventory (interest expense), and allowances for returns and defective merchandise. If you pay any salespeople a commission or spiff, that needs to be taken into account, too.

For service work, you have to cover your direct labor costs on each job. These include not only an appropriate portion of your technicians’ annual salaries, but also their benefits, payroll taxes, unemployment insurance, worker’s compensation insurance, etc

What about the cost of your time? Whether you are a one-person business or simply provide indirect supervision of your staff, your time is a cost that has to be covered. One way to approach this is to divide what you expect to personally earn on an annual basis (including those items above but not your profit from the business—I’ll talk about that later) by 2,000, which is roughly the number of working hours during the year. Let’s say your “salary” plus benefits is $100,000. Your hourly labor cost is $50. Multiply that number by the hours you estimate you’ll personally spend on the job, add in the other worker’s costs, and you have your direct labor costs.

These aren't the only factors, so check next week for more guidelines on pricing for profit.

Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.

Negotiation Success Is Planned, Not Accidental

Mention negotiating to some people, and the first image that comes to mind is a table full of lawyers and accountants haggling over a billion-dollar contract. In most small companies, you seldom get involved in those kinds of deals, but you do conduct negotiations of many kinds all day every day—sometimes without even realizing it. You negotiate with suppliers, customers, service providers, even employees. You give and take over everything from delivery dates and financing terms to whose turn it is to clean the coffee pot in the break room. Perhaps the most important negotiations, though, are the ones you conduct with vendors and suppliers. How well you perform there can make a major impact on your company’s success.

Obviously, being a good negotiator can improve your bottom line. Less obviously, though, when you improve your negotiation skills you also reduce some of the stress that comes along with running a business. You’ll enjoy both wider profit margins and fewer headaches if you’re prepared for the negotiating process and ready to use your skills when the need arises. Before you begin a negotiating session, you need two things: information and a game plan.

Information is something you can’t have too much of. You need to know as much about the other person’s needs and wants as you do about your own. If you are negotiating with a vendor, how’s their business? Is this sale important to them or just routine? Are they operating under competitive pressure in the marketplace or do they have a monopoly? Is their plant running at full capacity? Is their warehouse bulging with unsold inventory? Is the rep over quota or desperate for a sale? Some of these things you can find out by asking them directly or just listening closely to casual conversation; others will take a little research in the trade press or a reading between the lines in your dealing with competitive vendors. In either case, the more you know in advance, the better off you’ll be.

Look at your own situation ahead of time, too. Get the facts and figures straight about what you need, when you need it, how much you’re willing to pay for it, and so on. The more solid information you have, the more confident you will be in making decisions—and such confidence will greatly influence the way the vendor responds to your offers.

Remember, too, that this information is as confidential as your bank account numbers. You don’t need to reveal it to the vendor unless it’s going to help you get something you want.

Successful negotiation is by definition a matter of give and take, which is where the planning comes in. Preparing a list in advance of the possible concessions you can make as well as a list of things you’d like to have in return is often a good idea. The list will help you prioritize your requests and make sure you don’t overlook any possibilities. As you’re drawing up your list, remember that negotiation isn’t just about price. Delivery schedules, payment terms, packaging and displays, advertising allowances, return policies, and many other elements can add (or subtract) value to the transaction. And nearly every one of them is negotiable, so it never hurts to ask.

You can also offer the vendor some items he or she might want besides a higher price, too. The size of the order comes to mind right away, of course, but what’s it worth to them to get a quick decision from you? Or how about payment in advance? While you normally don’t want to tie up your capital, if the price of the parts or merchandise you’re buying can be slashed below the cost of the money (the interest you would earn if you kept the money in the bank for the time it takes to sell turn the inventory, to look at it simply), it might make sense.

One of the preparatory steps I always found useful was to think through my final position—my least acceptable alternative—before I started negotiating. This might include the highest price I could afford to pay, the largest quantity I could justify ordering, the longest delivery date I could accept, and so on. I would try to include every factor that might come up and decide—in advance—the worst terms I could accept before walking away from the deal.

What we’re talking about here is my “take it or leave it” offer. I would certainly never reveal it to the vendor, but knowing where I stood gave me a scale on which to measure possible concessions that I was either willing to make or that the vendor offered as the negotiation continued. Knowing the ultimate bottom line ahead of time also kept me from making costly mistakes in the heat of the moment.

The other thing to prepare in advance is a wish list of everything you could possibly want from the vendor. Don’t keep anything off the list just because you think “they’ll never go for that.” You don’t know unless you ask!

Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.