Welcome to our Dear Strictly Business advice column, brought to you by our pals at Xero. This is where you ask the questions and we hunt down the answers. For this round, we’re answering one reader’s question about…dun dun duuun! Your product-pricing strategy.

Pricing is one of the most important steps of setting up your small business. It’s a balancing act: you have to value your time as well as get people excited about what you’ve made. It’s not just about plugging costs into a formula, either – there’s a psychology behind boiling down the numbers and settling on a price that feels right for your ideal customer. To get the inside scoop, we spoke to the people behind three very different businesses (all Xero customers, by the way).

Our expert panel:

Elisha Watson – CEO and founder of Nisa, an ethical underwear label that employs women from refugee backgrounds.

Karyn Parkinson – Co-Director of Unstoppable eCommerce, a marketing agency that helps businesses run e-commerce stores.

Waan Pivasiri – owner of You, Me & Bones, a hand-poured soy candle company, and yes buddy reusable bags.
Waan Pivasiri

Tell us about your business and what inspired you to start it.

Elisha: Nisa is a social enterprise that makes ethical and sustainable underwear, swimwear and sleepwear. Our garments are made in our workshop in Wellington, New Zealand and we employ women from refugee backgrounds.

Waan: I wanted to start a craft-based hobby in 2013 and began experimenting with different crafts. I ended up falling in love with candle-making. That’s how You, Me & Bones was born. I’ve also recently started another brand that sells reusable bags made out of recycled plastic called yes buddy.

Karyn: We help eCommerce entrepreneurs to sell more on their online store. We work with businesses of all sizes, though with that said, we focus on helping small businesses get on a level playing field with the big guys using Facebook Ads and other online marketing strategies.

Do you use a formula in order to calculate the price of your products?

Elisha: We don’t have a set formula. We usually start our design process by thinking about what price point we want to hit. Then we work backwards from there. Most apparel brands, for example, use a similar formula where the retail price is approximately 4.5 times the cost of making the garments. This works if your cost of making is low (for example, by producing cheaply offshore) or if you’re happy with luxury prices, but we want the best of both worlds – ethical and sustainable production with accessible pricing.

Waan: Yes! It’s just a simple one I've been taught by other makers along the way. I really do recommend it to anyone who's just starting out – it's pretty straightforward. Firstly, you want to know how long your product takes to make. Let’s say it takes you two hours to make 20 candles. If your wage is $50 an hour, that costs $5 of your time for each candle.

Add all of your material costs up for one candle, then add your wage for the two hours. Then you mark your price up for wholesale either by 30 per cent or 50 per cent (50 per cent seems to be the standard, but this is entirely up to you and what you sell). Then you mark up again for your RRP.    
Karyn Parkinson and Megan Winter

What are fixed costs and variable costs and how do they play into a pricing formula?

Karyn: Your fixed costs stay the same, regardless of how much you sell. These are things like the price of rent for a physical store or website-hosting fees for an online store.

Your variable costs, however, can change due to your sales volume. The more you sell, the more you can negotiate down the costs of your raw materials and even postage costs. To start, set your pricing based on your higher variable costs, and know that when you sell more you can then increase your profit margin, or even look to reduce your prices.

What kind of research should small business owners do before setting their prices?

Karyn: If you compete on price, it’s a fast race to the bottom. People who buy based on price are also only loyal to price. So although you want to be aware of what the market is doing, you don’t want to make your pricing decisions based on being the same or cheaper than someone else. Do your research on what people are willing to pay for your product but most importantly give yourself a healthy profit margin.

We recommend 80% GPM (Gross Processing Margin). You can then focus on building a great brand with quality products and excellent customer service to build a loyal community of customers who will purchase from you again and again.
Elisha Watson in the studio

Many makers don’t start out factoring in their own hours. How did you cost out your labour (making/designing/creating time)?

Elisha: When I started, I didn’t pay myself. Starting up a business is extremely time-consuming and profits don’t usually come right at the start, so building Nisa from the ground up was definitely a labour of love. I now pay myself a small salary, which is super-exciting because it means we have grown to a level of greater financial stability.

In terms of working out the right time to take on new people, it’s always hard to get the timing perfect. With taking on new sewers, it’s usually quite obvious as all I have to do is look at our ‘to be made’ pile and if it’s getting out of control, we look to take on a new team member. With admin and marketing jobs, it’s a bit harder to work out the right time to take the plunge, but usually it’s because an opportunity crops up or the right person comes along.

Waan: Ask yourself a very blunt question: if you don’t value your time, how do you expect others to value it? I totally understand that it’s hard to factor your time into the costs, because of course it brings the price up, right? But you have to pay yourself and $2 an hour just won’t do. I find that using the formula I mentioned where I make in bulk and charge per hour for those 20 or whatever candles works best for me. This will also give you a good indication of what your wholesale order minimum cost could be.

How do you factor in potential discounts into your margin?

Elisha: Nisa doesn’t do sales, except to clear stock in our seasonal ranges such as swimwear. We do small-batch production, where we have very few items of each style at any time. When we’ve almost run out, we make another small batch. This means we’re not wasting resources by producing things that people don’t want. Given that our profit margin is smaller than most manufacturers, it wouldn’t be very practical to sell at large discounts. Instead, we compete on quality and standing by our values of community, sustainability and empowerment.

Waan: I mark up for wholesale and mark up again for RRP. This means I have lots of room to have sales.

Karyn: This depends a lot on your business model, but if you’re discounting all the time, your customers will get used to it and wait for the next sale, rather than purchasing at full price. I recommend using discounts sparingly, but by having a healthy profit margin to begin with, you can afford to use them on special occasions such as Black Friday.
Waan Pivasiri

How do you use Xero to stay on top of stock quantity and profit margins?

Karyn: My advice is to start the way you want to end up doing things. So even if your stock levels are small to begin with, get in the habit of using Xero to monitor stock quantities and values so you always know where your profit margins are at and how much product you have. This will set you up for success when you have a lot more stock on hand.

Waan: You can get different useful reports from Xero where you can see how many of what stock you’ve sold in a time period, as well as the revenue. You can also see sales by items, which I find super-useful, and if you want to see who buys the most popular product in your inventory, you can use the Inventory Item Detail report. All so handy for different reasons!

Do you integrate it with any other programs?

Elisha: We use Xero together with Airtable, a spreadsheet-database hybrid software, to make a really powerful system that deals with pricing, re-ordering and production. Shopify runs the sales side of things.

How do you approach price increases and communicating this with your audience?

Elisha: Thankfully, price increases are something we don’t have to deal with too frequently as we have great ongoing relationships with our suppliers. However, if we were to raise prices, transparency would be the priority. Increasing prices are the reality of selling in retail, and we would rather add a few more dollars to our prices rather than cutting corners and providing our customers with a worse product. We’re fortunate to have an amazing customer base that gets behind our cause and our journey.

Waan: I did one price increase a few years ago because I had to register for GST. I increased the main products by $5-$10 and felt like I had to be transparent with my customers and explain to them in a blog post why I had to increase the price. (To be honest, I was also afraid of the backlash if I wasn’t transparent.)

When other makers ask me how they should price their items, I always suggest a higher number to cater for when they have a sale on. It’s also much easier to decrease your price than to increase it. You don’t have to register for GST when you first start your business, but you do have to when your annual turnover is $75,000 or more.

Karyn: Your pricing sets the tone for your business and your products so you don’t want to be making big shifts often. You can, of course, make small changes over time. When you do, it’s important to give your customers a heads-up. We recommend a marketing campaign giving your current audience at least two-weeks notice of your incoming price range, which will give them the opportunity to buy from you before the price goes up. Not only are you making them feel special by giving them advanced notice, but it’s also a great way to get some last-minute sales before the impending price rise.
Karyn Parkinson and Megan Winter

What’s the deal with GST?

Karyn: In Australia, all your pricing needs to be displayed including GST if you are registered for it, so you need to factor this in when setting your pricing.

If you’re not registered for it, but think you may need to soon, I recommend factoring it into your pricing from day one, then absorbing the 10% when you register for it, rather than not including it and having to put all your prices up 10% later.

How does software like Xero help with all that GST stuff at tax time?

Karyn: You can automate your in-store point of sale, or your eCommerce website to talk to Xero and sync all your sales data. This way you will always have an accurate record of your revenue and be able to see where your income streams are coming from as well, making you ready for tax time.

What is psychological pricing and would you recommend using it?

Karyn: The most common is rounding down a number to be below a whole number so it looks cheaper. For instance, $9.99 looks cheaper than $10. As a whole, we don’t like to insult people’s intelligence too much these days and have moved away from using this with cents, though we still use it with whole numbers such as $19, rather than $20, or $197 rather than $200. Ending prices in a 7 became popular as 7 was deemed a ‘buying number’.

Interested in learning more? Here are Karyn’s resources for further reading:

- 10 eCommerce metrics you must track and measure

- How to set your product pricing

This little chat took place in collaboration with Xero, online accounting software that's committed to supporting small businesses. Download Xero’s free Stronger and Smarter Handbook for practical insights to help keep your business moving into the future.