Getting the pricing right for your product or service can be one of the most difficult tasks for a new business owner. There are three things you need to consider and calculate to help you determine your pricing.
So, let's look deeper into each one.
Gross Profit is - “the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.” For example, if you build chairs and sell your chair for $100 and it costs you $50 worth of materials and you build the chair yourself so you don’t have any employee labor cost, then your gross profit is $50.
There are a couple of things to consider with gross profit as it relates to pricing. You will probably be able to find an average gross profit margin percentage for just about any industry with a little bit of time spent searching on Google. Sticking with the chair example, you can find that the average gross profit margin for manufacturers (which is what you are doing, you are manufacturing a chair) is between 25 and 35% according to Chron.com.
So now as a chair manufacturer, you know that you should shoot for at least a 25% gross profit margin.
To calculate the gross profit margin you just take your sales price of $100 minus your material costs minus your labor costs to come up with your gross profit. Then take your $50 gross profit and divide it by the sales price of $100 to come up with your 50% gross profit margin.
Right now we are more profitable than the industry average. But remember you are not paying yourself. Think about this in apples to apples. You need to track how many hours it took you to build the chair, then determine what you would have to pay someone per hour to do that same work. Let’s say it took you 3 hours and you think you could find someone to do the work for $15 per hour. Now add that $45 of labor cost in and instead of a 50% gross profit margin you only have $5 of gross profit on the chair, just a 5% gross profit margin.
As you are pricing your products and services, you really need to consider what the labor cost would be if you weren’t doing the work yourself.
Aim for an industry average gross profit target, it is the industry average for a reason, whatever the gross profit target is in your industry is likely at that level because that is where your gross profit margin needs to be in order to operate a sustainable and profitable business.
In our chair example, first determine the cost of materials and the cost of labor. If you had to hire someone to complete the labor, which we said was $95 in our example, then work backward to come up with what your price should be. Let’s say we price the chair at $130, our gross profit margin would be:
($130 - $95) / $130 = 26.9% gross profit margin
26.9% is within the range for the industry average gross profit margin, so $130 could be a reasonable price for the chair.
Now, the next thing to consider as it relates to pricing is what is your time worth? In the chair example, we assumed that we could hire someone else at $15 per hour for 3 hours to build the same chair. Since this is your side business, you are probably building the chair yourself. So, the question is whether you want to work for $15 per hour? You might have other jobs or side business opportunities where you could make $50 per hour. To be competitive with those other opportunities, you might want to charge your time at the $50 per hour rate. Now your labor cost for the chair just increased to $150 plus the $50 of material, your chair costs you $200 and you want to have a 25% gross profit margin because the gross profit will be used to cover your overhead expenses. All of a sudden you need to charge nearly $275 for the chair in order to maintain a gross profit margin over 25%.
It is possible that you won’t be able to find customers willing to pay that price.
The key for a long-term successful side business is to find a product or service that you are willing to provide at a price that customers are willing to pay. Much of this mental math comes down to the last point which is “what is your goal?”
The goal of your side business may have more impact on your pricing strategy than anything else. For example:
As you can tell, your goal for the business can have a profound impact on your pricing strategy. The key takeaway is that you should be pricing strategically. Pick a strategy and price accordingly. Too many entrepreneurs don’t do the math and they think they are earning more per hour than they actually are. It doesn’t matter which strategy you pick as long as you are purposeful in your pricing strategy.
If you have specific questions about how to price your product or service, please reach out, we would love to try to help you think through your unique pricing strategy. Here at Side Hustle University we serve as a course guide that is focused on encouraging you to create your own side hustle. We are committed to giving you the best opportunity to identify, shape, and build your business from the ground up. We encourage you to check out our website to learn more about how you can become the side hustler you've always wanted to!