[MUSIC] Before you start working on the business plan, there's a few things you have to get straight in your head. And one of the key aspects of your business is pricing. What is it you're going to do with regards to pricing your product or your service? Two attitudes that you can take here. The first attitude being that you can entertain the cost of your product at something to that for profit and the sum of that then becomes a selling price. This is known as full cost pricing. Alternatively, you can ascertain the price at which similar products are being sold. And then attempt to keep cost below that level so you can make a profit. Let's just have a little bit more about full cost pricing. Selling price is determined by calculating the total cost per unit of output. The total cost of the thing that it is that you're selling, and at a percentage, which we call a markup, to that particular cost. The difficulty is allocating what we call indirect costs, sometimes called factory costs. You may know them as overheads, okay? These can take the form of administrative marketing costs, etcetera. And sometimes it's difficult to identify with regards to these overheads how you're going to attach them, what we call apportion them, to the cost of your product. Of course, what's really required here, is that if you achieve your profit from your budgeted sales, then it's okay. One of the good things about using full cost pricing is when you're using it in contracting industries. Given a simple example, if you're a plumber, and you quote for a particular job, then you know that included in that quote will be the materials that you need, and the amount of hours in terms of labor that you'll be using. And also any other costs that are incurred. So using full cost pricing is quite useful in those sort of one-off type of situations where you're quoting for a specific job. It's relatively quick and cheap as long as you know what the cost structures are. And using full cost pricing is actually a useful method to justify any price increases. If some cost of yours goes up, then all you're doing is adding the same percentage to a high cost and thus increasing your price. Of course, it does cause some problems with the mark up percentages. What is the right mark up percentage? Is there a notion of a fair price? Mark up is influenced by what we call the elasticity of demand. I'll talk a little bit more about that later on. And, of course, using full cost pricing, if you're not controlling your cost it can lead to un-commercial prices. Some of the problems of course, if you don't achieve your budget in sales volumes. And then of course, you're not actually achieving your profit and potentially making a loss. It ignores factors such as competitor activity and price elasticity of demand. In other words, put a change in price, and how that affects your demand. Let's look at another method of pricing. We'll call this one marginal cost pricing. Previously, when we looked at full cost pricing, we spoke about adding the overheads to come up with a full cost. Marginal cost pricing can be used to determine the price that just covers not your overheads, but just what we call the variable costs. The costs that are specifically related to your producing or buying-in your products or services. This method of pricing is useful especially in short term pricing decisions. It's a way of taking advantage of temporary market difficulties, and maybe exploiting new market strategies. It may be used in preference to total costs. It's as accurate, just simply uses a larger markup. It gives you an awareness of the marginal or the variable cost. And therefore facilitate pricing below for cost of fuel capacity. It's good for pricing specific contracts and it recognizes what we call relevant costs. It also facilitates decision making when resources are scarce and allows you to make the best use of those scarce resources. It's not, however, universally popular. The fixed cost, these overheads, may not be recovered in the long term. In other words, you may not actually recoup all of the costs that you spent on these overheads. It may encourage price wars. So where you're pricing your product below others using a marginal cost method. Others might need to follow suit to match you. And therefore, for you, there's a downward spiral in terms of price. And it can make it difficult to raise prices, especially when your markups are very low. Let's look at the factors affecting your pricing policy. The first factor being price sensitivity. In other words, how will your product to all service react to a changing price? How sensitive is it? This will obviously have an impact on the demand of your product. If it's a very sensitive product to price changes. What about price perception? Sometimes, certain businesses can actually charge a higher price to try and get the image across that it's actually a high quality product. It may not be, but it's how people perceive it. And of course, there is the issue of quality. What sort of product or service is it that you want to deliver? If it's a high quality product, the chances are that it's going to have a high cost, which will impact on your price. Low quality product, well, a low price, but you'd then expect potentially to maybe selling more volume. Are there any intermediaries, someone who sits between you and the customer, some sort of middle person who's in on the deal? This needs to be taken into account because they're going to want their profit as well. So when you're pricing yours, if there's someone who sits between you and the customer, and they need to add their profit on top, you'll need to maybe reduce yours slightly. What about your competitors? What is it that they're pricing their products at? And how, this is important, will they react when you come in with your price? Will they try to match it? Will they try and go below it? What about your suppliers? If someone's supplying you with the goods, materials that you're using to manufacture or make your product, then what if they put their prices up? In other words, your cost increase. Are you going to suffer that as a business, or will you pass those on to your customers? There's a little bit of leeway in there, but of course that's a decision that you're going to have to take. Of course inflation as well, what do you do with inflation? Some things inflate at different rates. What sort of inflationary measures are there in your particular product or service? And how will you react in terms of changing your price with regard to inflation? What about newness? How new is the product? Is it innovative? Is it something no one's seen before? This particularly affects the technology industry. And I remember many years ago when CDs were first introduced. And the first CD player cost around 2,000 pounds. I walked into my local supermarket recently, and saw a CD player there for about 10 pounds. It's old technology now. But, if your product is new and hasn't been seen before, then maybe you can command a higher price. Incomes, and in particular disposable incomes, of course you need to think about where your product sits. Is it a high quality product? Are you trying to sell to a very limited range? Or is it a pile them high, sell them cheap, type of product? Therefore, income will have a direct impact on your selling price. What about the product range itself? I'll talk a little bit more about this later on, but do they compliment each other? Is it just one product that you're selling, or are you selling a whole range of products? And, therefore, sometimes having a low price for one, allows you to maybe charge a little bit more for the other. Ethics play an important part in your pricing attitude or range or even strategy. I'll give you a personal example about ethics and maybe how people take advantage at certain times of the year. I remember I used to use a florist on a weekly basis and take my wife home a bunch of flowers. And I remember at one particular point in time and I can tell you may know the date it's the 14th of February, Valentine's day. I went in there to buy a lovely bunch of flowers for my wife and they'd increase the price by three or 400%. Of course I never went back there again because that's me. And although I love my wife, I don't love her that much. However, joking aside, ethics does play an important part. What about if your competitor suddenly goes bankrupt? Will you increase your prices to take advantage of the fact that maybe now you've got a monopoly situation? Ethics is an important aspect that you need to bear in mind when pricing your products. And also what about substitute products? What else is there that could be substituted? Of course, a couple of obvious examples just so you understand what I'm talking about here is substituting your train journey for a bus journey. Is there a readily available substitute? Because if you price your products to highly, then maybe people will switch to that alternative. [MUSIC]
