In this example, we will take you through all the steps above and calculate a specific price. The entrepreneur in our example has developed a new type of chair made of a material that has never before been used in chairs. During a target group analysis, the entrepreneur found out that potential customers are eager to pounce on the new product and are willing to spend up to 100 pounds per item. The market analysis revealed that prices for other suppliers of high-quality chairs range from 80 to 120 pounds.
Now we have to address the cost calculation. The expenses for raw materials play an especially important role here. In addition to the entrepreneur himself, there are two employees who work on producing the chair. Costs for the machines, production, and storage spaces, office work, logistics, and marketing are also added. In addition to these prime costs, the businessperson calculates a profit margin of 35% and a discount of 15%. Since it’s just starting out, the new business would like to use affordable prices to get the customer’s attention.
Material direct costs | 22 GBP |
+ Material overhead costs | 6 GBP |
= Material costs | 28 GBP |
+ Manufacturing direct costs | 13 GBP |
+ Manufacturing overhead costs | 8.50 GBP |
= Production costs | 49.50 GBP |
+ Administrative overhead costs | 8 GBP |
+ Sales overhead costs | 3.50 GBP |
= Prime costs | 61 GBP |
+ Profit margin: 35% | 21.35 GBP |
= Total | 82.35 GBP |
- Discounts: 15% | 12.35 GBP |
= Retail list price | 70 GBP |
Even with a relatively high profit margin of 35% and a discount of 15% factored in, the customer is probably willing to pay, as the listed sales price of 70 GBP is still under 100 GBP. The following year, the company might be able to increase sales, which would sink the overhead costs and as a result further increase profit.