Price Your Product Introduction
Learning how to price your product to increase profits is a valuable skill set and a must-have if you want to start and/or grow a successful business that is both fulfilling and prosperous.
You have designed and created a product… now how do you price your product so that you can maximize your profits?
If you sat down and visited with five different saddle makers or leather craftsmen, you would certainly get five different methods to accomplish the same goal. Some of them would be good ways to go about this and some would be not so good ways. There is always more than one way to skin a cat… or maybe here, skin a cow… or use a cow’s skin… you know what I mean.
When I started my shop in 2004, I was a kid fresh out of college with many hours of science and chemistry on my transcript but not one business class. This whole world of entrepreneurship was very new to me and pricing was not my strong skill set. I read a lot about pricing strategy and proper accounting to maximize profits in a business. I also talked with many different craftsmen about their pricing formulas and the feedback I got was all over the map.
Over the last 14 years or so, I have bump along learning from my mistakes in pricing and am currently using a system that I feel is a great starting place when I am pricing goods and services in my shop.
This system is nowhere near perfect and I am always looking at the data and working to improve it. I do not make claim that this is the perfect formula to price your product. I do feel that it accounts for many areas of pricing that so many craftsmen and business owners leave out of their equations.
If you would like to have a Free PDF Worksheet to use in reference to this article, then just enter your email address in the form at the end of this article and we will send that right over to you!
Hourly Labor Wage-Your Time is Worth Money
Obviously, the first thing we need to do is decide on how much you want to charge per hour for the work you are doing.
The thing that I like to always look at is, how much could I make working for someone else doing something else and not have all the stress and responsibility.
It is really easy for us, since we love what we do, to just do an “apple to apple” comparison of other jobs we have had or a job we currently have and say well that is what I want to make an hour. This is leaving out some real key areas of your business that do not exist in an employment situation… lights, water, insurance, nighttime tooling sessions trying to stay caught up because you are the only one working in the business.
You can’t just say “Well I make $25 an hour at my day job, so I want to make that doing leather work.”… or worse, “I would “like” to make that doing leather work someday.” This will insure that you are always short on cash and struggling to grow your business.
Let’s define the hourly “Shop Rate”…
Shop Rate definition: Total of what you need the shop to generate for every hour that it is running so that ALL of your costs, overhead, and labor charges are accounted for within that hourly shop rate.
To come up with the shop rate, I like to look at the entire business as a whole from a previous year. The Profit and Loss statement is a great way to quickly gather this data… you can get this from a recent tax return. Take all the total expenses for the business and what you would like your salary to be out of the business.
This is important, you need to include a salary or wage for yourself in with expenses. Your income is technically whatever is on the bottom line as a sole proprietor but you still need to include a reasonable wage for yourself as an employee. The profit of the business is not your wage.
Add these two numbers together and this will give you a number that is minus cost of material… we know what material cost is per job so we don’t need to figure that in here… plus it is different per job.
Now take that number and divide it by 12 months in a year and this will tell you what the business needs to generate per month to not only break even but also pay you.
Now take that monthly number and divide by the number of days you want to work each month on average.
This is your daily shop rate and what your business needs to generate in revenue each day that you work. You can now easily divide this number by the average hours you work in the shop in a day and now you have a hourly shop rate.
*Note: If you have full time employees working with you in the business, their payroll expenses and wages should be included in your expenses total from the Profit and Loss statement as well. If this is the case for you, then you will need to divide this hourly shop rate by how many employees you have total including yourself. If you have one employee, then you would divide this number by two and this will give you the hourly shop rate per employee.
Look at this number now and see if it is even close to the number that you would normally charge per hour to price your product…. now you can be sure that you are charging enough per hour to do more than just cover your expenses.
A great video that I shared about the daily shop rate was done by a guy I follow on youtube who does woodwork named David Picciuto and he has a great way of looking at this. I don’t think this should be your only pricing strategy as it leaves a lot of the variables out, but it is useful when you are trying to ballpark a custom job for someone on the fly. You can see that video by CLICKING HERE.
Time is Time… Whether Repair or Custom Work… Your Time is Worth Money
Now that we have our hourly shop rate, we can use this number against any billable hours of labor used in the shop on a project.
This does not change between types of work being done. Whether you are doing a repair on a lady’s $10 handbag from walmart, or you are creating a high end saddle for a wealthy client, you should price your product and services using the same hourly rate no matter the job.
Sure, the charge for the purse repair may very quickly get over what the cost of the purse was new… this is not your fault. The customer is the one that purchased the item and now is wanting it repaired so that is their cost to absorb not yours.
If you can get your full rate working on the high end saddle, then why would you pull off of that job to repair the $10 purse… sounds crazy, but I have seen (and done myself) many quality craftsman do this on a daily basis and then wonder why they are struggling to make ends meet.
You have to decide what is worth your time and what isn’t. It’s not being ugly or snobbish, it is simply a math equation and you have to be sure that you are doing the best you can to give your business the best opportunity for it to survive and grow. So from repair to custom to high end art pieces… set your hourly rate and stick to it. This will insure that all your project bids are fair and correct and that they will make you money.
Material Cost – Finding, Ordering, Getting it Shipped and Unpacking is Worth Something…. You Should Make a Margin
We can now figure out what the Material Cost, or Cost of Goods Sold (COGS), are for the particular job that you are working up a sales price for.
Most folks will just look at their invoice when the material comes in and just use the unit price for the material used. This is leaving out a few expenses.
When you procure materials for a job, there are certain costs associated with finding that material and having it shipped to your shop. If you do not account for these costs, you are actually losing a bit of money here.
One of the first things to consider in your unit costs for material is shipping. Many times the material in one shipment is for multiple jobs within your business so it can be difficult to determine what portion of the shipping charge on that shipment would need to be added to the material for that job. This is where I use a percentage markup on the unit cost of material used to cover this expense.
The percentage markup that you decide to use is completely up to you, I use 20%. This seems to be a common markup on material across many trades… woodworkers, plumbers, mechanics, etc.
This 20% markup seems to be appropriate to not only cover the shipping charges, but also covers the time spent finding the material to order, time on the phone ordering the material, time spent unpacking the material when it arrives as well as the cost of waste you will have to deal with after the job is completed. Although you can use the scrap from the job for other jobs, you will still have to deal with the scrap at some point in the form of disposal and/or storage. This percentage markup will help to absorb the cost of the these expenses.
Special Order Items – Margin Can be Different on These Depending on What it is
I consider special order items anything that you are not accustomed to having to order on a normal basis.
Most of the time you can use the same markup from your normal material markup, but there are times when less or more would be more appropriate. These items could include custom hardware such as saddle conchos, saddle rigging dees, custom belt buckles, or specialty excotic leathers and skins. Depending on the item, you may have room to charge a higher markup just based on the nature of the item and the demand in the marketplace.
Silversmiths and jewelers do this quite often. Precious metals such as silver and gold allow for a much higher markup just on the material itself. This allows them to increase profits simply by using these metals versus nickel or steal.
There are times where we too as leather craftsmen have this opportunity as well. Say a customer wants American alligator versus Caiman crocodile… though we will spend much more for the same size skin in American Alligator, we can also mark the material cost up more than we would the Caiman if we choose to simply because of the demand and perceived value of the skin. The same would go for other highly excotic skins that are more difficult to find and purchase.
This obviously is your choice as the craftsman. You may choose to not mark up your special order items any higher than normal material and that is absolutely fine. I sometimes will not mark stuff up as high as I probably could and I still make a profit. The point here is to be aware of the extra costs associated with having to procure special order items versus normal everyday materials.
One note here has to do with custom hardware from another craftsman. In my mind, if the customer can contact the hardware craftsman on their own and order the hardware needed for the job and he/she would be quoted the same as I would be for the items then I only mark up the items ordered enough to cover any shipping charges incurred. To me I don’t feel right about charging the customer more than they would have to pay for the item had they just called and ordered it themselves and had it shipped to me. This just seems fair in my mind.
Total Job Cost – This is Your Cost of the Job NOT the Sale Price
So now we have our hourly rate (or day rate), our material cost plus markup, as well as any special order items plus any markup. With all these variables in place, we now just have to total up our labor in hours and multiply by our hourly shop rate.
Now we have all the costs of the job… Material cost, labor cost, and any special order materials. All of this totaled together will give us our Total Job Cost.
Notice this does not say Total Sale Price. This number is not the price at which you would sell the item to the customer. Unfortunately, this is the number that most people will use as their sale price for the item. This leaves out two very important numbers that are important for the health of your business… Overhead and Profit
The total job cost is only the actual hard cost of the job. This number takes into account every part of the job that consumed resources of your business. There is a small amount of profit worked into this figure which will help to cover any miscalculations of time spent on labor but not enough to grow your business.
The way to look at this number is this: This is what you would have spent out of pocket if you didn’t work in the business and were only a silent owner of the business.
So at the end of this particular job, as the owner you would have paid for the material, any costs associated with them, paid your rent and utilities, and paid your employee who actually made the item… but there is nothing left for you to take out of the business as an owner.
Added Business Costs – Sales Call Costs, Overhead… This Gives a Total Gross Cost for the Entire Job Start to Finish
Added Business Costs are any costs incurred on the business that are not directly associated and expensed out on a particular job.
These costs may include time spent on the phone with a client who is ordering a product, time spent fitting their horse to get a saddle sale, time spent doing your taxes, time spent writing out checks to pay bills, time spent unclogging the toilet in your shop or just sweeping the floor. The point is that not every single hour of shop time is used and expensed out on an actual job… but the costs are still there and very real.
To help make sure that these costs are covered, I use a percentage factor per job to help compensate for these costs. I use 15% of the total labor cost per job. If the the labor cost of the job was $600, then I would multiply that by 15% and add $90 to the bid. This would be that job’s contribution to any indirect charges the business incurred during the time the job was being worked on in the shop.
Another cost that I add here is the Sales Cost of the job.
It is really hard to keep track of time spent to close every sale. But there is real time spent on marketing, phone calls, facebook ads, social media, etc just trying to get orders in the shop. We can not disregard that time spent in our calculation.
I use a percentage of 10% of the labor charges here. I use the 10% number here because if you were to hire a full time sales person who worked on commision to sell your products, then you would most likely pay them 10% of the sale. Now, I use the 10% of “labor cost” not the sales price of the job so theoretically this wouldn’t be enough, but it is a good start. If you ever do higher a full time sales person, then at least you are covering some of the commission costs.
Profit – This is Where the Business Makes Money… As Well As You
Here we are at the main number that most people leave out of their equation. This is the all important “Profit” number.
Your business can not grow and prosper without this number. If you leave this number out of your pricing, then you are simply breaking even on each and every job and you do not own a business… you own your job. Not to mention you are doing all this and dealing with all the added stress for a wage. We aren’t doing this to just earn a wage, we are doing this to create a business that we love that will provide for us and our family for years to come. A healthy business is a profitable business.
Now we have a Total Gross Cost of this job in both direct expenses as well as indirect resources consumed by the job. Now with this number we can add our profit margin to get to the final sale price of the product.
This is a good place to visit about the difference between Markup and Margin. The “markup” of an item is what percentage the item is marked up in order to get the profit “margin” that you want. These numbers are not the same. Many folks will decide that they want to make a 40% margin on their money per job so they just mark up their cost by 40%… this is incorrect.
If you buy a piece of hardware, say a buckle, and it costs you $3 and you want to sell that buckle and make 40% on your money in the form of profit margin, then you have to come up with the proper markup on it.
If you just do a markup of 40% then you would sell that buckle at $4.20 or a markup of $1.20. So if we take the $1.20 markup and divide it by the sale price of the buckle to see our profit margin then you will notice that this ends up being 28%… that is a substantial distance from the 40% we set out to make. This is the difference between markup and margin.
If we take the same buckle, and instead, do a markup of 65% then we would add $1.95 to the cost of the buckle giving us a sales price of $4.95. Now if we divide our markup of $1.95 by the sales price of $4.95 we get a margin of 39%… that’s better.
The amount of profit margin that you want to make on your money… and it is all your money… is completely up to you. Different industries and products allow for different profit margins so you just have to decide what the market will allow for your work.
I have found that with my custom products and saddles, the 40% margin works well for me… sometimes I don’t get all the way there on each and every job, but by year end I can usually average a 32% – 36% net margin across the entire business of total revenue.
The main point here is that the “bottom line” on your Profit and Loss statement when you do your taxes is all that matters to the health of your business. If you ever wanted to sell your business or want to know the value of your business, it will be some factor multiplier of that bottom profit margin (usually 5 or 10). So do not leave this number out of your pricing equation.
Now that we know what markup and margin are, what do we do.
We simply take our total gross cost of the job and multiply it by the markup that we decided to use so that we can create a profit margin that we are happy with.
I use the 65% markup that I referenced above and this nets me a margin of 39% … or close enough to 40%.
We can check our work… $665.22/1688.65 = 39% margin. The job and all costs and profits are accounted for and this is the final sales price that we should sell the item for or do the job for.
Sales Price – This is the Full Retail, MSRP, Sticker Price…. Will the Market Bare This Price?
After all these mathematical gymnastics, we have come to a final sales price for the item or service. When I get to this point, I take a minute to look at this number and ask myself one question:
Would a customer pay this for it?
This is the point in the process when you can feel confident that you have accounted for all costs associated with the job, have paid all wages (including your own labor), and have a healthy profit in the figure for the business. Well done… you have done a good job!
But now we have to take a good hard look at this number and think about the reality of whether or not the item or service offers enough value to demand the price we have come up with. This can be a hard question to answer.
The reality is that sometimes the number may seem a little low and sometimes it may seem a little high… or even super high!
This is your moment to make a decision as the business owner. Since all the money in the job is accounted for, you have the option to lower or raise the price from this point to get the number where you think it would need to be. The good thing here is that you can make an educated decision here instead of just guessing and spit balling.
Many times I will go through this process and come up with a sales price that is way to high in my opinion for the item or service. At this point, I make a decision based on my gut. If the item is something that I really want to make then I may lower the price to a more appealing amount. I do this knowing in my mind that I will not maximize my profits on that particular job… if I am okay with that then I move forward and feel good about it.
There are times when I look at a particular item and feel that the market would never pay that amount for the item and I am not really excited about the item anyway. Should this happen, I make the decision that I will not make that particular item since it doesn’t interest me and I will not make much money on it.
I would rather not make any money in the my business than lose money in my business.
The main takeaway here is that no matter what the number comes out like, you will have all the data accounted for accurately. From here you can make whatever decision you would like on the pricing from here… but at least now you have a better understanding of money you may be leaving on the table or jobs you are hitting a home run on.
I know this article may have seemed super boring and may remind you of sitting in math class, but this subject is where most of us fall short within our businesses and we can’t ignore the math if we want to succeed.
There are definitely different ways to price your product and services within your business but this is the best way that I have found to at least have a benchmark for pricing. It can be really easy to just look at what others are charging for their items and services and go with that. And usually this will get you close. But for me, I have learned that this isn’t always accurate and if “everyone” isn’t charging enough on something and losing money, then why would I want to follow down that path.
Pricing is as much of an art as what we do in our workshops, but it doesn’t have to be a mystery.
The quickest way to turn a passion that you love into a nightmare is to drop the ball on pricing and have the business struggle financially. This will lead to resentment in your work as you work tons of overtime at low wages and zero profits trying to save it. This will turn your once loved hobby into a grinding J.O.B.
I hope you found this article insightful and can implement some or all of this into your pricing strategy. No matter what process you use, take some time to assess your prices now to see if you are doing a good job of working to increase the health of your beloved business. What we do is fun, fulfilling, and empowering… work as hard on your business as you do in your business.