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How to Price a Product (Part 2/2)

The second aspect of pricing a product, then, is “what do you need to make?”  There’s room for some artistic license here, but “two times variable costs” is a good rule of thumb.  To explain, let’s start with two definitions:

Fixed Costs:  The money it takes to run your farm or business, without ever making a product.  This includes property taxes, building maintenance, and most electricity bills.  Conveniently, in a small farm, many of the fixed costs are part of running your household anyway. 

Variable Costs:  These increase when you make a product.  For example, chicken feed for broilers is a variable cost.  It increases only when you’re feeding a chicken for sale.  Packaging for eggs is also a variable cost.  Labor directly related to production is a variable cost, like the hourly rate for feeding the chickens. 

Lets go back to the egg example, a dozen eggs selling for $6.  As mentioned before, the variable cost (also known as cost of goods sold in this case), should be half of the selling price.  Thus, if you can make a dozen eggs with $3 in variable cost, and sell it for $6, you make a $3 gross profit per dozen, and should be decently happy with yourself. 

The gross profit, of course, exists to first absorb your fixed costs (if you sell 1,000 dozen eggs, your gross profit can absorb $3 x 1,000 or $3,000 of fixed costs).  Once your fixed costs are absorbed, the rest is PROFIT!

To summarize, (1) the market determines price in direct competition.  You determine price when you have a unique product that customers want.  (2) You should be happy to sell your product for two times the variable costs you spent to produce it.  And (bonus), once your gross margin (the money left over after variable costs are covered) exceeds your fixed costs, you make a profit!

That’s a mouthful, I know.  Write me a note or a comment with any questions!

Christian

 

 

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Uncategorized

How to Price a Product (Part 1/2)

“If I sell eggs and lose $1 per dozen, how many dozen do I have to sell to break even?”  It’s a silly question, of course, but I’ve seen countless well-meaning farmers try to answer it by trial-and-error, on their way to getting a job in town.

I’d rather ask, “if I sell eggs and make $3 per dozen, how many do I have to sell to quit my job in town and make my dream job my real job?”

What’s the difference between the two farmers asking the questions? One of them knows how to price a product for sale. 

There are two aspects to pricing any product:

1.  What will the customer pay?

2.  What do you need to make?

Let’s start with the first one, “what will the customer pay?”  It’s really the most important, because it doesn’t matter what you need to make on a product if no customers will buy it at that price.  To begin, consider existing pricing in the market for products similar to yours.  If three farmers in your town are selling a dozen eggs for $6, that’s probably what people will pay.  Its not likely, if your eggs cost $9, that people will buy them.  That is, UNLESS (and this is a BIG idea when it comes to small business strategy) your product is BETTER.  If all the farmers in your town are selling eggs (pasture raised) for $6, you can charge more money if you offer something better, like pasture raised PLUS organic certification.

A strategic aside:  The best businesses in the world grow not by offering incremental improvements on existing products in the market, but by offering something completely different.  A famous egg farmer in Italy sells his eggs for $18/dozen.  How?  His chickens roost in trees.  He feeds them organic grains raised on the property and soaked in milk from a goat herd that exists only for the chickens.  He spends several hours each day hunting for eggs in trees, on buildings, and in shrubs.  And he’s happy to have help from every journalist and high-end restaurateur who wants to join him.  His product is better.  It’s more fun, and has NO EQUAL.  In that case, he gets to be more creative with the price.  (The opposite, of course, is what economists call “perfect competition.”  The best example is corn sold to the co-op; all suppliers bring an equal product, and the market dictates the price.  This environment is bad news, and best suited for going out of business unless you are the most efficient producer in the market.)

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