There’s no denying that pricing is crucially important. It defines the value of your product, services, and business as a whole, and acts as a reflection of what you work towards as an organization.
Your prices are the final point that lets a customer know whether or not your business is worth investing their time and money in. Getting it right is therefore a delicate balancing act, one that needs to be struck between maximizing profits and maintaining healthy sales.
But how can a price be set effectively? One option is to use the price margin model.
What is a Pricing Margin?
A pricing margin is one of the most important figures for a business to know and understand. At its essence, a pricing margin – or profit margin – is the difference between the cost of an item and the price at which it is sold. The aim, therefore, of most businesses is to make as much margin as possible while ensuring prices stay competitive.
Margin versus Markup
Most people are already aware of what a markup is. When a company sells a product, they will typically sell it at a higher price than it cost them – enabling them to make a profit. This difference in price is the markup. Margin-based pricing is very similar, only it takes more factors into account.
When placing a markup on a product, it will usually involve applying a percentage to add on to the price. So, if a product costs you $100 and you wanted to make $10 per product sold, you’d sell it for $110 – a 10% markup.
When calculating a price margin, however, other costs like utilities, transportation, property rental, and staffing costs, et cetera, are also taken into account. So you will need to calculate how much these extra costs apply to each unit. How do you do this? By taking the total of the extra costs and dividing it by the number of units you expect to sell.
Once you have worked out what all the other costs are per unit, you then add this number to the cost of the product. So, if the product costs $100 and additional costs are $10 per unit, you come to a total of $110.
At this point, we only have the break-even figure, without taking profit into account. Let’s say you want to make a $10 profit per item; we take the $110 we previously came up with and add the $10 to come to a price of $120.
Why is Margin-Based Pricing Important?
A price margin model is important because it lets you more accurately work out how much profit you are likely to make at a certain price. It might be tempting to look at your competitors and try to undercut them to grab a market share. However, this approach can leave you selling a product for less than what it cost you, meaning you’re actually making a loss overall.
Margin-based pricing helps you know how much you need to sell a product in order to make a profit, rather than setting a price just with sales volumes in mind. If the price after all costs plus your desired profit is too high? Then you’ll know the product is not viable and that you should focus on investing in another product, or at least consider changing product specifications to reduce the cost.
Know Your Margins: The Benefits of Margin-Based Pricing
Knowing pricing margins is one of the key steps in figuring out if a profit can even be made, and how much volume will need to be sold to do so. Margins are ultimately one of the most crucial aspects of a pricing strategy, affording organizations valuable insight into their business performance. Here are some major benefits of knowing your margins:
Margin-based pricing also gives you flexibility. It helps you to determine your break-even point accurately so you can calculate the impact of discounts and promotions, and so on, from there. If you’re planning a sale, for example, then a price margin model will let you know if the additional revenue from making more sales is equal to or higher than the total revenue from making fewer sales but without any changes in pricing.
The whole point of a sale is usually to increase profits, not only sales, so if additional profits aren’t made? Then you’ll know the sale is not worth it, at least from a profitability standpoint.
Maintaining Brand Value
Previously, we mentioned the risk of devaluing your brand, and it’s something to take into account when it comes to your price margin. In many cases, reducing prices to increase sales will improve your profits. But that’s not the full picture. Because if you reduce your prices too much, then it might give the impression that your products, and your brand, are of poor to middling quality. It can be very difficult to lose this reputation once acquired so it’s something to take into account when setting your price margin.
Maintaining a high price margin is something that exclusive brands are always mindful of in their pricing. Take Rolls-Royce automobiles, for example. You’re very unlikely to find a brand new Rolls-Royce discounted because the company wants to maintain the brand’s image as being exclusive. When discounts are implemented, they’re typically “hidden” ones.
Even if keeping a high price margin might reduce profits in the short term, it’s beneficial for the company to maintain its reputation for exclusivity over the long term. If you want a brand new Rolls-Royce? Then you’ll need to pay a high price margin for it, which helps to make them more desirable to those who can afford it.
The Advantages of a Pricing Margin Model
With a price margin model, it becomes easier to find the right balance between making sales and the profit per unit sold to improve your profit overall. A pricing margin model also makes it easier to see the benefit or otherwise of discounts and promotions, and helps you to make the right decisions when it comes to which products to invest in.
To sum up? Margin-based pricing can help you to maximize our profits in the long term, helping to give you a very desirable edge over the competition.