Pricing Your Product or Service

2. Building a Cost Structure

Your cost structure provides a basis for what you need to charge. But it will not necessarily show you what you can and should charge.

2.1 Divide your costs under two headings: variable and fixed.

• Variable costs will increase when your sales increase (eg goods and materials).
• Fixed costs remain largely constant, regardless of how much or little you sell (eg rent, salaries, business rates).

2.2 As long as the price you sell at is higher than the variable cost, each sale will make a contribution towards covering fixed costs - and making profits.

• For example, a car dealership has variable costs of £9,000 per car sold and total fixed costs of £200,000 a year. The contribution required depends upon the volume of sales. If the company sells 80 cars each year, it needs a contribution of at least £2,500 per car (ie £200,000 divided by 80) to avoid making a loss.

2.3 Based on this cost structure, the company can assess the consequences of different price levels.