Pricing for Profit

Most businesses operate with the idea that profitability is a natural occurrence or that the challenge of developing profitable products or services is so simple that there is never a need to review pricing processes.

 

Often times I hear business owners, CEOs and even CFOs touting their business success due to profitable performing products and services where I often wonder what their true understanding of pricing is as it relates to profitability.

 

Sure all business wants to be profitable and all business believes they are actually profitable, but there is a large percentage of businesses out there that do not understand the concept of profitable products or services.

 

A truly profitable product or service must at least breakeven in preparation for profitability.  Understand that the most common definition of breakeven is the point at which a product or service does not win or lose.

 

In other words, a product or service that has the ability to breakeven actually has no loss or gain either way.  We need to understand how to add the percentage of profitability onto the known breakeven number, which is where we will really get our profit.

 

The term of breakeven in production and fabrication is where one can determine the number required to produce to breakeven.

 

For example, if I were a manufacturer of joist hangers, I would want to know how many joist hangers I need to produce to cover my raw materials costs otherwise known as breakeven, where all the joist hangers I produce after that known number would be profit.

 

Contractors are a good example here where most contractors will factor in all of the raw materials costs of each project and add what they believe is an acceptable percentage of profit. 

 

The error here is that contractors mistakenly factor in their labor costs into what they believe is their profit margin when at the end of a project they really do not profit what they think they should because the project took too much time to complete via labor expenses.

 

Unfortunately for most contractors and most businesses, that perceived percentage of profit that is added to the raw material figure is in fact just a perception of what they believe to be profit.

 

Smaller contractors and smaller businesses that operate as sole proprietors and are in fact truly operated by one person, really don’t have to worry about the actual calculation of breakeven and proper pricing as much as the other businesses.

 

The key to proper pricing for profit is to capture three important parts of the pricing equation.  The first being direct costs; those are costs that you pay for in order to sell what you sell.

 

I will post more to this topic in the coming days. Check back often.

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