Know Your Costs and Price for Profit
Price is the dollar amount that you ask for sales of a product or a service. There are various costs that go into deciding what price you will charge for your product, including:
- Variable costs (VC): Costs of inputs such as fertilizer, seed, utilities, and labor. If you don’t cover these, you will have to shut down in a short amount of time.
- Fixed costs (FC): Costs of ownership such as rent, equipment, depreciation, interest, repairs, taxes, and insurance. If you cover these you will meet your breakeven cost to the business, but have nothing left for yourself. Every item should contribute to ownership costs. If you don’t cover ownership costs, you will have to shut down in a longer amount of time.
- Profitable price: the prices you must charge to cover variable and fixed costs, plus payment to yourself and money to reinvest in the farm to assure long-term viability.
Value vs. Price
Many direct market farmers are afraid to charge what they need to in order to have some profit for themselves. You are providing more value to the buyer as you are closer to the customer.
Value = Quality + Service + Price
Value can mean different things to different customers. Value does not always mean “the most quantity for the least cost.” Understand what your customers value through your marketing plan (see Factsheet #40). In some cases, customers might value things like knowing their farmer or availability of hard-to-get products, and might be willing to pay more than the average price. For example:
- Your buyers want a quality product that you can provide because you can grow varieties for flavor instead of travel characteristics.
- Your buyers want to know how their food was grown. They like the fact that they have a relationship with you. This takes time on your part, but they are willing to pay for it.
- You can introduce them to new products and ways to cook specialty items. This is education that they are willing to pay for.
- Fresh un-waxed products, less fuel used, and community support are also cited as reasons many consumers are willing to pay more for local products.
- You can charge more for early season products when customers are eager to taste the first fresh local strawberries or sweet corn, so strive for early sales.
Calculations for Determining Price
Cost and Profit Method
Add your variable cost + your fixed costs + profit needed for the particular product = Income. Divide this by the number of units produced = price/unit.
For example: If it costs you $3,000 total variable costs and $2,000 total fixed costs and you want $2,000 of profit for a specific product then your total income from that product needs to be $7,000. Divide this by the number of units produced, and you will have the price per unit ($7,000 / 950 units = $7.38/unit).
Gross Margin Method
This method derives from the whole business sales, costs, and planned profit. This method is usually used by retail businesses that resell products. An example of gross margin method in a vegetable business might be:
- Know your total expected vegetable sales = $10,000;
- Know your total fixed costs + desired profit = $3,000 (this is the gross margin needed);
- Divide your gross margin by total sales: $3,000/$10,000 = 30%;
- Know your unit variable cost = $5.00; and
- You divide the unit price by 1- 30% of the unit variable cost to determine the price ($5.00 / (1-30%) = $5.00 / .7 = $7.14 per unit).
Going Rate for Market Area
Many beginning farmers start out with a pricing strategy that reflects what everyone else is charging. While this is a good place to begin, it is not where you want to be forever. It is important to know your costs and price for profit.
Plan for Profit
Sometimes it is better to sell fewer at the higher price than sell more at the lower price. For example, what if you price corn at $3.50 per dozen according to your calculations, but your neighbor is charging $3.00 per dozen? Can you still make a profit by lowering your price? If your margin on the $3.50 is $0.50 toward profit and you sell 300 dozen, that will give you $150 in profit. You would have to sell 600 dozen if you sold at $3.25 to get the same profit. For a 7% decrease in price you have to sell twice as much product.