Set Targets for Profitability To set your profitability targets, the first thing you should understand is your cost structure. With this information, you’ll know how much profit you’re generating at different prices and how low you can go and still earn the desired profit. Companies calculate these costs differently, so verify the exact calculations your company uses for Cost of goods sold (COGS): the cost to physically produce a product or service Gross profit: the difference between the revenue you earn on a product and the cost to physically produce it In addition, understand how much profit the company needs to generate. You’ll be far more effective when considering discount promotions – you’ll know exactly how low you can go and still be profitable.
Summary EXERCISE SUMMARY
When to Address
Who Should Participate
Where to Use the Results
After you’ve determined your pricing strategy If you’re planning a campaign and need financial measurement for ROI calculations or special pricing offers Business leaders: company founders, owners, presidents and vice presidents Marketing and sales leaders Financial leaders Product managers Channel managers Your cost of goods sold and pricing floor will help you determine your final price.
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Your need to know your COGs and price floor to stay profitable. Your profitability and market share growth rate greatly depend upon your pricing structure. What Builds Upon it If you have access to your cost data, this exercise is straightforward and should Timeframe to take roughly 15 to 30 minutes. Completion Potential Business Medium Impact Why it’s Important
Deliverable
You’ll determine your cost of goods sold and the lowest price you can charge without losing money.
Next Steps
Evaluate your competitors’ prices.
Target Completion Date
PARTICIPANTS TASKS
PERSON RESPONSIBLE
DUE DATE
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TASKS Notes
PERSON RESPONSIBLE
DUE DATE
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Set Targets for Profitability
What to Complete
1. DETERMINE COST OF GOODS SOLD 2. SET PRICE FLOOR
Where it Fits in Pricing Match Pricing Strategy to Value Proposition Define Pricing Strategy Determine Cost of Goods Sold Set Price Floor Review Competitors’ Prices Determine Price Analyze Competitor Price Changes Determine Competitor Price Change Response Gather Price Sensitivity Data Determine Price Elasticity Find Optimal Price Calculate Profitability on a Single Deal
1. DETERMINE COST OF GOODS SOLD
Let’s start with a few important definitions: TERM DEFINITION
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Cost of Goods a.k.a. Cost of Goods Sold a.k.a. COGS
The cost to physically produce a product (or deliver a service if you’re in a service business). For a product, COGS may include the costs of the raw materials, the costs to ship and store the raw materials, labor to assemble the product, and other costs to actually put together the object that you sell. COGS is a tricky figure and companies calculate it differently. We can provide basic information, but you should talk with your accountant/ CFO/CEO/owner to discuss the proper method of calculating the number for your business.
Gross Margin a.k.a. Gross Profit Margin a.k.a. Gross Profit
The difference between the sales price of an item (revenue) and the cost to physically produce it (COGS). It’s often expressed as a percentage: Margin = (Revenue – Cost of Goods)/Revenue The margin is the % of the revenue that is “profit”. In other words, a 60% gross margin means that 40% of the product’s sale price is the cost to produce it and the other 60% is “gross profit” before expenses such as marketing, salaries, rent, etc. The higher the gross margin, the more money a company has for expenses like salaries, research and development, marketing, or to pay down debt or pay back investors.
Product or service
Does your company already have your Cost of Goods calculated? Cost of Goods
STEPS TO CALCULATE COST OF GOODS If you don’t know your Cost of Goods (COGS) for the products or services you’re trying to price, talk with your finance team to determine them, OR Use 66-‐A and 66-‐B to document to put together your own estimate. (You may still want to talk to your finance team, or you can do your own estimate and firm it up later.) Use 66-‐C to COGs if you wish.
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2. SET PRICE FLOOR It’s important to determine your price “floor,” the minimum price you can charge to earn a reasonable profit. Here are the steps you’ll follow: STEPS TO ESTABLISH A PRICE FLOOR
Once you have your COGs, enter them in 66-‐D. You’ll also need to establish your desired Gross Profit Margin % for each product. Again, your finance team is the best resource for this data. If you’re having trouble establishing a Gross Profit Margin that’s appropriate, ask your finance team or owner for potential industries or public companies that you can research to get that information. You can also just ask them to give you an estimate. 66-‐D will give you a minimum price that you can’t go under and still generate the desired level of gross profit. Enter those values below: DESIRED GROSS PRODUCT COGS PRICE FLOOR MARGIN % If your value proposition and brand is focused on cost leadership/low price, the prices shown above are probably very close to where you should be – as long as you’ve been realistic about the margin %. However, it’s helpful to continue and evaluate your competitors. If their prices are lower than your floor, you’ll need to lower your COGS or desired gross profit margin in order to compete. You may print 66-‐A, 66-‐B or 66-‐D to use as your reports if you wish.
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