If I haven’t told you my failure story with my business, the summary is that I shutdown two of my businesses after close to three years of running them because I didn’t understand cash flow
Because I didn’t understand cash flow, my pricing was always poor
And, even when my business partner tried to call my attention to the wahala, I followed her points by saying
Amazon lost a lot of money when they were growing, loosing money is needed to grow a business
You have to invest first and then, make money later
The business will not make profit for the next 5 years, we simply need to get more customers first
My case was a case of knowledge =1 Application=0
I had read books about business but, I was reading and understanding it completely wrong from how it is applied
These lessons will show you what to do and not do when it comes to pricing your product
These lessons will guide your pricing and reduce the chances of you ending up like I did
Lesson1: Customer First, Price Follows And Then Product
Too often in business we start by creating the product, adding a price and then, trying to sell to the customer
This then opens the door to all the friction we will face to make a sale
This friction being because the product -customer -price don’t match and, of your product and price don’t match your customer it simply means you built a product for the wrong customer
So, what to do instead?
Define who your customer is.
Then, based on who they are, define their financial capability
After this, validate their financial ability by asking questions in a way that lead to results
Then, based on your answers and all data gotten, build a product that the customer will gain the most value out of at the price point they can pay
You do this by
- Finding a way to create a product at a cost that will meet their price not going to spend and have increased cost hoping they will increase their buying ability later
Please, note that, doing these doesn’t mean you have an excuse to build a low value product
There are ways to build a high quality product without loosing value and all while keeping cost down, find it
2. Cost Is Of Two Kinds, Most Starting Business People Forget The Second One
Cost in business can be direct or indirect cost
Direct cost is a summary of all you spent to produce a unit of your product or service
Indirect cost is a summary of all you spend to run your business
the direct cost of creating a dress is
- Cost of fabric
- labour cost
- cost of packaging
- cost of dry cleaning and ironing
- cost of weaving
- cost of any added accessories to make the dress ( zips, buttons, fringes or the sort)
The indirect cost of making a dress would be
- Fuel to run run the shop on a daily with or without the dress
- Transortatiom to go to work with or without the dress
- Feeding money at work with or without the dress
- Internet paid with or without the dress
- Cost of usinf your home for work with or without the dress
- airtime you spend in a month with or without the dress
- Salary you pay with or without be the dres
- Nepa bill you pay with or without the stress
- Machine maintenances without or with the dress
Now, most starting or aspiring to start entrepreneurs think cost starts and ends with direct cost
In the end , you are loosing money and your business is struggling to grow
How to fix this ?
Write out your indirect and direct costs, leave nothing out and write them separately
Then, add up direct cost, all direct cost will have to be used for one unit of the product
So, if the direct cost of a dress is
- Cost of fabric = 600 X 3 yards : 1800 NAIRA
- Cost of Labour = 2,500 NAIRA
- Cost of weaving and ironing = 250 NAIRA
- Cost of packaging -500
- cost of accessories ( Zip &a Fringe) = 500
- cost of shipping = 1,000 Naira
- cost of transportation = 500
- cost of fuel to produce this one dress = 1,000
- Total direct cost = N7,050
Then the indirect cost of the dress is
- Cost of rent = N60,000 ( monthly is then 5k)
- Cost of internet = N15,000
- Cost of Water = N1,000
- Cost of fuel to run the business = N10,000
- Cost of salary = N0 because I am outsourcing
- Nepa bills = N7,000
- Airtime cost= N2,000
- Total direct cost = N40 ,000 ( rent is split into 12 months
We will then have to split these figures into smaller units that will enter for each dress we sell
How do we do this?
We set a sales target of say 10 dresses per month
Then, we break our indirect cost into smaller bits
- At 10 dresses , rent is now = 500
- At 10 dresses : Internet is now = 1,500
- At 10 dresses, water is = N100
- At 10 dresses , fuel is = 1,000
- At 10 dresses , airime is =200
- At 10 dresses, total cost =3,300
Based on this, the final cost of the dress is = N10,350.
Imagine how much the business owner will loose when calculating just direct cost.
This point brings me to lesson number 3 when it comes to pricing
You really need to know your numbers.
You are loosing money if you do not have a proper record where you store all data
You are also loosing money if you decide to omit some costs
For example, from the direct cost list, I ommiteed the cost of photography.
When I was in fashion, I stupidly would spend N35,000 on product photography. Then, I would completely omit that fee.
That is 3,500 naira omitted if I was targeting to sell 10 dresses monthly.
Add up all costs and forget natin, don’t even remove a drop of water.
The next lesson is
Margins Determine Markup and Profitability
Please, Stop deciding your markup out of the blue.
“Add an amount you want to add on top of the price” is a pricing system for people who have made it and are big enough to choose the level of profit to get.
Me and you who are still trying to grow the business, we neva grind beans.
Instead, use margins.
Let me explain margins for you in a way you will get it
Say a business owner made sales of 1,000,000 naira last month only
And another business owner made 100,000
You will say their sales is really booming and the business is financially healthy.
You will even say “at this rate, the business will be very successful”.
Now, say the business of N200,000 naira sells their products for N20,125 each and the cost of production is
This sets their profit margin at 13.4%
And the business that has made N100,000 sells their products for N10,500 each but, their cost is N3,500
Their gross profit which is revenue-cost = N7,000
Setting their business to 66.67%% in profit margin
Which business now looks like something worth investing in?
Which ones looks like it is growing all things being equal?
Use the shopify calculator mentioned in this blog post to calculate your profit margin before setting a price
How do we do this?
After calculating your cost, choose a profit margin between 35% and above.
Any margin below this is for businesses that can compete on scale and so, have the volume in sales to make profit and be able to grow the business.
I will share how to reduce cost if the cost is now way more than you want it to be because you want to target a budget market.
But, for now, let’s get through this
So, for now the pricing process you need to know is
This is the most effective pricing process for any business.
Now, based on this analysis, are you loosing money or making money?