How to Price Your Products for Profit

KES 15. That is how much Musa was losing on every pair of leather sandals he sold from his stall in Malindi, and he did not know it for two years. He priced them at KES 700 because that is what the stall next to his charged. He knew the leather and the sole cost about KES 440, so he thought he was making KES 260 a pair.

He was not, because he had left out his own time and his stall rent. Learning how to price products for profit starts with that uncomfortable sum, what one item really costs you, all in. Musa's numbers below show how to find that sum and why markup and margin are different. They also show how a "small" discount can cost far more than it seems.

Work out what one item really costs

Most traders count only what they paid for the goods. It is one of the most common pricing mistakes in small business. Everything else the item needs, from your hours to your rent, gets left out of the sum. A true cost has three parts:

1. Direct costs: materials or stock, packaging, and transport to bring them in.
2. Your time: the hours it takes to make, prepare or sell the item, valued at a fair hourly rate. If you do not count it, you are working for free.
3. Overheads: rent, power, permits and other costs you pay whether you sell one item or a hundred. Divide them by how many items you sell in the period.

For resellers who do not make anything, part two is smaller, but it is never zero. Time spent buying, cleaning, sorting and selling still counts. A trader who spends a whole morning at the wholesaler has spent real working hours. Leaving them out makes every price look more profitable than it is.

Musa's sandal: the full cost

Musa's sandals show what happens when all three parts are counted. The materials were the only cost he had ever added up. His time and his stall rent had never appeared in the sum at all. Here is what one pair of plain leather sandals costs Musa to make:

At KES 700, every pair lost KES 15. Over a month of 60 pairs, that was KES 900 short. In practice it meant he was not even earning his own KES 150 an hour, and the business itself earned nothing at all. He had been calling his wage "profit".

Markup and margin are not the same

Two words get mixed up all the time, and the mix up costs money. Both describe profit as a share, but a share of different things. Using the wrong one can leave your price far lower than you meant it to be. Here is the difference:

• Markup is profit as a share of your cost.
• Margin is profit as a share of your price.

If Musa adds a 35% markup to his KES 715 cost, his price is about KES 965. But his margin, the share of the price that is profit, is only about 26%. If he wants a 35% margin, he must price at KES 1,100, because KES 715 divided by 0.65 is 1,100. The same 35% gives two prices KES 135 apart.

Decide which one you mean before you set a target. Most business advice about "healthy margins" means margin, the share of the selling price. If you set a markup when you meant a margin, your profit will be smaller than you planned. Writing the target as a share of the price avoids that mistake.

Check your price against the market

Your cost tells you the lowest price you can survive at. The market tells you the highest price customers will pay. A good price sits between the two. If the gap between them is too narrow, the product itself may need to change.

Musa looked at who actually buys from him. Local customers compare with the stalls around him and rarely pay above KES 900 for plain sandals. Tourists in the high season care more about design than price, and they buy beaded sandals as gifts. So he made two products, one for each kind of customer:

At 60 plain pairs a month, the plain sandal alone now brings KES 11,100 in profit, on top of his wage. That is the difference between a business and a job that pays badly. Every beaded pair sold in the tourist season adds KES 285 more. The two products together let him serve both kinds of customer without dropping his price for either.

The real cost of discounts

Discounts feel generous and cheap. They are rarely cheap. A discount comes straight out of your profit, not out of your price. That is why a small cut in price can mean a large cut in what you keep.

When a customer asks for 10% off a KES 900 pair, the price drops to KES 810. His cost does not change, so his profit falls from KES 185 to KES 95, nearly half. Smaller discounts follow the same pattern. Here is what each one does to the work needed to earn the same month's profit:

To earn the same KES 11,100 at a 10% discount, he would have to make and sell 117 pairs instead of 60, nearly twice the work. Now when customers ask for a discount, Musa offers a free cleaning of their old sandals instead. It costs him little and keeps his price whole. The customer still leaves feeling they got something extra.

Raise prices without losing customers

Many traders fear that a higher price will drive everyone away. Some customers will leave, but often fewer than you fear, especially if you raise prices carefully. The ones who stay are paying a price that keeps your business alive. These four habits make a rise easier to accept:

• Raise a little, not a lot. A step of KES 50 to KES 100 is easier to accept than a sudden jump.
• Add visible value. Better packaging, a neat finish or a promise of free repairs makes a higher price feel fair.
• Explain honestly. "Leather went up this month" is a reason most regulars understand.
• Offer a cheaper option. Keeping a basic product lets price sensitive customers stay.

Review prices whenever costs change

A price that was right in January can be wrong by June. When Musa's leather supplier raised the price from KES 280 to KES 340, his full cost rose to KES 775. At KES 900, his margin would have dropped to about 14%, and his monthly profit on 60 pairs from KES 11,100 to KES 7,500. That is KES 3,600 a month lost to a rise of KES 60 in one material.

Musa's answer was a small, honest price rise. He raised the plain sandal to KES 980, which brings his profit to KES 205 a pair and his margin back to about 21%. Recalculate your full cost every time a supplier, your rent or your transport changes, and at least once every three months anyway. A cost you check often never grows into a two year loss like his first one.

Pricing is one of the pillars of small business management in Kenya. It sits at the centre of how to grow a small business in Kenya, because growth needs profit to fund it. Once the margin is right, protect it. Musa moves part of each week's profit into a Nyanyuka savings goal, from KES 10 by M-Pesa, locked until the date he chose, to buy a better cutting tool before the next tourist season.

Part of: Running a Small Business in Kenya: Money, Records and Customers

Frequently asked questions

How do I calculate the selling price of a product?

Add up every cost per item, then divide by one minus the margin you want. The costs include materials or stock, packaging, transport, a fair value for your time and a share of rent and other overheads. Finally, check that price against what your customers will actually pay. For Musa, a cost of KES 715 and a 35% margin gives KES 1,100.

What is a good profit margin for a small business?

A good margin varies by business, so there is no single figure. Fast selling goods like vegetables often work on smaller margins, while handmade or specialised products need larger ones because each item takes more time. Work out the margin that covers your costs and a fair wage, then see whether the market supports it. Musa's plain sandals now run at about 21%, and his beaded ones at about 26%.

Should I include my own time in the cost?

Yes, because if you do not, you are working for free and may be pricing below your real cost without knowing it. Choose a fair hourly rate, count the hours each item takes, and include that in the cost. Musa's 1.5 hours a pair at KES 150 an hour added KES 225 to every sandal. Leaving it out is how he sold at a loss for two years.

Is it better to sell more at a lower price or less at a higher price?

It depends on how much extra you would really sell. A small discount can mean selling far more items just to earn the same profit, as Musa's table shows. Work out the sums for your own product before cutting prices. At a 10% discount, Musa would need 117 pairs to match the profit of 60 at full price.