A lot of times, I hear from people who are planning to start up some kind of new business, usually something online. Often, I hear from people that I really don’t know well, but who follow me through my various websites, but sometimes the people I hear from our good friends. Usually, people who write to ask me questions are looking for business advice. Sometimes they are just so excited about their new business idea that they want to share it with somebody. I am always happy to listen, and I usually try to offer some kind of advice to these folks, trying to help them succeed. Sometimes, they appreciate the advice, other times they actually get offended, especially if I think that they need to think their idea through a little more carefully. Honestly, if I offer advice that they need to think it through more, I am only trying to help them out, saving them from frustration that they will certainly be facing in the future, given their plans.
One of the biggest issues that I see people facing is that they have improperly priced their product or service. When you are going to offer a product or service, it is important that you consider all of the costs involved in offering the product that you have in mind. Most people forget about many of the costs involved in their offering.
Sometimes, I get e-mails from people who actually have really good ideas for a product that I believe is very good, but they have not thought through the pricing carefully enough. I remember one time a while back, a fellow had an idea for an item he was going to sell online, and I thought it was an excellent idea. He told me that the item cost him $10 to produce. He was planning to sell it for $11. I wrote back and told the fellow that he was going to lose money on every single sale. Although this incident is 100% true, there is an old joke along these lines:
We lose a little bit on each sale, but we make up for it with the huge volume!
As any businessman would know, that statement is impossible. If you lose a bit on each sale… the more you sell, the more money you will lose! I wrote to this fellow and explained to him that he was going to lose money with his idea, but that he should consider raising the selling price to better cover his costs and to also make a nice profit. His product was unique enough that he could have easily sold the product for $20 or $25, and still sold a lot of them. However, this fellow got angry at my reply and told me that I didn’t know what I was talking about.
Well, let’s look at this. If you have a product that costs you $10, can you really sell it for $11 and make a profit?
The first thing to make sure of is to figure out if it really costs you $10 to buy or produce the item. Perhaps he was right, maybe it really did cost him $10. Let’s give him the benefit of the doubt and agree that it really did cost him $10, and not a penny more.
He will still lose money. How? Why?
The reason that he will lose money is that there are other costs to consider other than just the cost of the unit. This fellow was talking about selling his product online, on his own website.
OK, it will cost money to build and maintain the website. The design itself, even if you do it yourself (which I generally do with my sites) costs money to make. If not direct out of pocket money, your time has a value, right?
Next, it costs money to keep your website online. You need to pay a hosting company for space where you keep your website. For a cheapie host, you will probably spend $8 to $10 per month for that. If you have a serious business going, you might pay a lot more. If you have a lot of traffic and need a dedicated server for your business, you might be paying $200 to $1,000 per month for the dedicated server. I have, in the past, paid as much as $250 per month to host my websites. That is serious money, and you must recover that money, and also you need to consider that as part of the cost of selling your good or service on the Internet.
Next, if you are going to be selling a product or service on the Internet, that usually means that you will be needing to accept Credit Card payments or some kind of online payment. This costs money. It is cheaper if you live somewhere like the USA, although it still costs money. But, if you live somewhere like the Philippines as I do, credit card transactions cost serious money. A mainstream credit card processor will not accept your business if you are not in the USA. So, you have to find a service that will accept your business, and they will charge more because they feel it is a higher risk dealing with a business in a country like the Philippines. About the best, you will be able to do is to find a processor who will charge you 5% of the price of the product, and also a “per transaction” fee, of around 30 to 50 US cents. You have to pay these fees for every single item you sell. Many processors, on top of the fees that I mentioned, will also charge you a monthly fee just for using the service (or not using it, if you have no sales). This could run $100 or more per month. So, if you sell one of those items for $11, just the credit card fees alone will cost you $0.85 or so, perhaps more (and this doesn’t even count any monthly fee).
So, on that $11 sale, you just made a huge profit of 15 cents. And, you also need to subtract off all of those other costs that I mentioned. Also, you didn’t pay any employees to do the work involved – remember, there are office tasks, packaging, shipping and other duties that must be done to complete the sale. So, even if you don’t even count the web hosting and such, you made only 15 cents on an $11 sale. So, let’s say that you do $100,000 in sales per month (which I doubt this fellow would have even been close to), your profit would have been $1,300. Can you imagine how much work you will need to do to successfully process and complete $100,000 in sales in a month? My friend, add in the real costs of employees, web hosting and all that other stuff, and you just lost money by selling $100,000 worth of goods.
So, it is important to consider all of your costs in doing business. If you don’t, you will lose money. And, don’t forget that your time has a value too. If you are working 8 to 12 hours per day, and not considering that time as part of the cost of doing business, well, you are not really being serious about business.
I have never owned a business but I worked in retail for about 5 years long ago.
The way it was explained to me was that if the store bought an item for $5.00 and sold it for $10.00 that was a 50% markup. Out of $10, 50% went to the wholesaler and 50% went to the store. Is that how it works?
It always seemed like a 100% markup to me.
Hi Danny – Exactly right. If it cost you $5 and you sell it for $10, that is a 50% markup, or more accurately called a 50% Gross Margin. For a retailer, there is no such thing as a 100% Markup, because that would mean that the item had to cost you nothing to obtain, and there ain’t no such thing. 😆
It seems to me that this guy has never owned a business, nor has ever worked in retail…Either of these two things would have given him the knowledge to price his product accordingly….The general public is woefully unaware how businesses really work.
Hi Mike – I fully agree that the general public has little or no idea how business works! It is so obvious by the things you hear from people’s mouths.
Sorry Bob but I really have to disagree with you on this one !! lol
If you buy something for $5 and sell it for $10 that is a 100% markup- NOT a 50% market up !
Markup as a percentage
Cost x (Markup + 1) = Sale price
or solved for Markup = (Sale price / Cost) – 1
Assume the sale price is $1.99 and the cost is $1.40
Markup = ($1.99 / 1.40) – 1 = 42%
To convert from markup to profit margin:
Sale price – Cost = Sale price x Profit margin
Margin = 1 – (1 / (Markup + 1))
Margin = 1 – (1 / (1 + .42)) = 29.5%
Ian – I have been a retailer for more than 30 years. Retailers generally talk Gross Margin. I thought I was clear about that… maybe not. Still, that is not really what the article about anyway.