Understanding Pricing

Posted 4 Dec '20

Understanding Pricing

By Charles Talbot

At some stage in the business lifecycle, most business owners will struggle with setting the price of a product or service. A range of factors can impact pricing. Keep reading as some of the factors around setting price and understanding your business costs are explained in more detail.

Supply and Demand

If demand for goods or services in your industry is greater than the supply available - prices typically will be increasing. The same is true in reverse. Prices will normally be falling if supply is greater than demand.

Price elasticity of demand is a term all business owners should familiarise themselves with. This is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change.

We are number nerds, so mathematically it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

A price increase doesn’t always result in an increase in profit and a price decrease does not always result in a decrease in profit. For example:

• If your business sells goods and reduces pricing by 5% but has a 10% increase in units sold you will see an increase in gross profit of 4.5%.
• If your business sells goods and increases pricing by 5% but had a 10% decrease in units sold you will see a decrease in gross profit of 5.5%

It’s about understanding how changes in your pricing will impact the demand and in turn your bottom line. It is also important to understand any resulting changes to your costs. Will an increase or decrease in the units ordered, see a change in my individual unit cost or associated costs to sell those goods?

Cost of materials and labour:

In the service industry the cost of materials and or labour is a key factor when setting price. Far too often we find businesses don’t truly understand their labour costs.

For example, a junior employee could be being paid $14 per hour - this is not your true cost of this employee. Let’s break this down and take into account:

• 4 weeks annual leave (including holiday leave loading),
• up to 2 weeks sick leave,
• up to 8 weeks TAFE or study leave (assuming 1 day for 40 weeks of year),
• 2 weeks public holidays,
• 9.5% superannuation and
• workers comp (estimate of 3%).

The true hourly rate cost of this employee – for the hours you have them available – is $23.09 per hour.

For some industries, price per square metre of the job is regularly used when setting price. In these circumstances, it is vital to understand the cost of labour and materials to complete these jobs. This will ensure you are making a margin and prioritising the right work for your business.

There are many other factors to consider when setting price and job costing. There are various job costing software solutions that we can work with you to put in place. If you have any question on pricing or understanding your business costs – do not hesitate to get in touch with me or your WDF contact. Phone 02 6921 5444 or email ctalbot@wdf.com.au.