One of the most critical areas of pricing that we all have a tendency to fall short on is understanding our true production cost. If you don't understand or know your true production cost then your pricing is nothing more that a crap shoot because you have nothing to base your pricing on!
"Sell it for what the market will bear"; I hear that a lot as advice on how much you can get for your work, but I feel that's a very misleading statement and you really need to fully understand what it means before you settle for a price and you certainly can't base your prices strictly on that factor. Here's my point; if it cost you $30.00 to build something, and you feel the market will only bear $20.00 for that same item, then you should go ahead and price it at $20.00 because "that's all the market will bear"? I hope not!
So what does that mean? Is that the only option you have or do you have to figure out how to build it for less then $20.00? Or do you have to find a different product to sell? Or Maybe you could find a different market for your product so you can sell it for more. But before you get to that point and try to answer some of those question, you really need to know what it truly cost to build it in the first place.
So let's take a look at how to determine a price for your work.
There are six things you need to consider when determining a price for what you build. Too many times as a hobbiest, a woodworker feels that anything he or she makes above the cost of materials is profit and then try to apply that same thought process to business. It just doesn't work that way.
Here are six thing you have to take into consideration:
- Material cost
- Fixed overhead
- Administrative cost (known as non-productive time and cost)
- Actual time to produce
- Labor cost.(What you would like to get paid for making and selling your product).
Material Cost: This is the starting point for figuring your cost to produce a project, but only the starting point. Just make sure you list everything in your material cost. (lumber,hardware, finishes, and all the small materials like; glue, screws, nails, sandpaper, clean-up materials, etc.).
Fixed overhead: This is your monthly bills to operate your business; like rent (or mortgage), electric, phone, internet, insurances, etc. Total these up for the month so you will know how much it cost you to run your business. (if you divide that total by the total hours you work each month in your shop, you will know how much it cost you per hour to operate your business).
Example: If your overhead is $1,000/month =$12,000 year and you spend 50 hr./wk = 2,500hr./year.
Divide $12,00 (overhead) by 2,500 (hours) = $4.80/hr. This is what it cost you every hour to operate your business whether you are building anything or not.
Administrative Cost (known as non-productive time): The average one man shop will spend approximately 25% of his time in non productive activities, (meeting with client's, doing proposals, running for materials, talking on the phone, advertising, marketing, cleaning up, etc.)
Actual time to produce: If you're lucky enough to get to build a proto type first, you should know exactly how long it takes to build it. If you're building it as a one on, then you need to know how long it will take you to build and finish each phase of your projects. Whatever the case; you need to know how many hours it will actually take to build your project.
Labor cost: How much would you like to make working for yourself? One thing to remember; you will be paying all your own taxes, social security, health insurance, retirement.
Profit: This is one area so many woodworkers don't even consider, but if you ever want to replace any tools or buy new or expand your business, you better figure in some sort of profit.
Now if you add up all the above segments to figuring your true cost of producing a project you will have your price you should sell your product for. This will have nothing to do with "what the market will bear" or even if you can sell your product for that price, but simply a true picture of cost. Then you decide if there is a market for your product, or if you need to see if you have to build it cheaper to be able to sell or maybe it's just not feasible to build and sell it for a profit.
Let's do an example so you may be able to better understand: We're going to build a nice birdhouse in our example.
Materials; Lumber,dowel for perch and porch rail, glue, primer and paint. Total $10.00
Your actual time to build and finish this birdhouse: 4 Hours.
Overhead; based on our earlier example @ $4.80 hr.
Labor: How much you would like to make. Lets say $20.00/hr.
Profit: Let's say you would like to make a 15% profit.
Now we can total up our total cost to produce this birdhouse Materials: $10.00
Time to build: 4 hours
Overhead 4 hrs. x $4.80 $19.20
Labor: 4 hrs. x $20.00 $80.00
Total: $ 119.20
This is your true cost to build this birdhouse. Now if you want to make an actual profit on this birdhouse then you would have to add in your profit ( $119.20 x 1.15% = $137.08
So, if you sell your birdhouse for $137.08, then you would be able to pay for the materials, pay for your 4 hours of overhead that it took you to build it, pay yourself for the 4 hours it took for you to build it and you would make a $17.88 profit for the business.
Here's the real kicker; have you ever heard of a woodworker that says he just uses a multiplier to figure their selling price? Some will say they take the material cost times 4 and that's what they will sell it for. What's wrong with this picture? First; it's obvious they have no idea what it truly cost to build their project and second; compare the two prices. If you take the material cost of $10.00 and times it by 4, you only come up with $40.00. Figuring it that way and you sold your birdhouse for $40.00, the only thing you would be able to pay for is the cost materials, the overhead and pay yourself about $2.55 hour and no profit (or if you want to say you made a profit, then you worked for absolutly Nothing!).
This is why so many woodworkers fail as a business. They just don't have a clue what the true cost of building a project really is and they somehow convince themselves they are selling their products for a profit. Don't fall into that trap!.
Holy Crap; can I sell my birdhouse for $137.08?
Now you have a few question you have to ask yourself and find the answer to.
1. Is there a market for my $137.08 birdhouse? (will the market bear it?).
2. If yes, then marketing is your next step.
3. If no; then what are my options?
Can I find a way to build this same birdhouse faster and cheaper and if so, how much faster and cheaper? Can I get it to a price point to be able to sell in my market?
Or can I look for a different market that would "bear" the price I need to sell my birdhouse at?
Bottom line; when all is said-n-done, it may not be feasible to find a market for your birdhouse and you may have to find another product you can produce and sell for a profit.
This reminds me of a story I was told years ago about the farmer from up "north", went to Florida and bought a truck load of watermelons for $2.00 each. He brought them back home and sold them at his produce stand for $1.00 each. Needless to say, he sold out very quickly and when his neighbor asked him what he was going to do since he didn't make any money, he said; "Guess I'll have to get a bigger truck".
I have a whole chapter devoted to "pricing" in my book, but for here, I hope I can at least give you some ideas on how to look at your pricing. There's still a lot more to it then that, but that's a start.
We'll talk about quality, marketing, image and some of the other factors later.