Pricing is every bit as important as the physical work itself. In some regards it is even more important than design ability because if the numbers don’t add up, regardless of how great the design and execution, the prospect for profitable success is limited. So, let’s dive in to the issue of price.
What is a Pricing Strategy?
Many people use a pricing formula, which is an essential part of setting prices, but, not all pricing formulas include a pricing strategy. A formula is an equation, whether simple or complex, and it entails adding up numbers and arriving at a selling price. And although a formula arrives at a selling price, that selling price may not guarantee profitability.
A pricing strategy is more comprehensive than a formula, and for a formula to be sound and profitable, it should be based on a strategic foundation. A pricing strategy includes more than just a formulaic equation of numbers; it includes a full accounting and understanding of what the numbers represent.
Knowing the numbers is the only way to make them add up in a formula that portends success as a business owner.
In the pricing formulas disclosed by many of this year’s applicants there were two noticeable categories which were lacking; the categories of profit and overhead. These are two areas we should examine in depth to determine what was overlooked or underestimated, and how to remediate that.
A pricing strategy requires a formula that ensures the selling price includes all the overhead and expenses of running the business and leaves nothing out of the product cost. In order to determine whether there is the ability to meet expenses, it is essential to know the actual production overhead costs of running the business.
Many formulas are based on a multiplier or factor for simple markup of costs such as materials and labor. Here are two formula examples that were commonly used:
labor + materials x (a number or percentage) = selling price
labor + materials + packaging x (a number or percentage) = selling price
The multiplier or markup percentage in these formulas is supposed to provide revenue above the cost of materials and labor to cover overhead and provide profit, but very few of the formulas cited an actual estimation of overhead costs or an indication of a profit margin. Without knowing the actual cost of overhead, or factoring in an amount of profit, it is impossible to know if a multiplier is sufficient to the task of ensuring profitability.
So, here is the great reveal about the secret pricing formula…….there is no secret pricing formula!
A typical formula based on someone else’s numbers that is not tailored to your exact situation, may not be functional for your actual costs and expenses. So, to be certain a formula works for you, you really have to know your own numbers. First and foremost, is overhead. Understanding this number is vital.
Calculating Overhead Costs
Evaluating the overhead costs, accurately, is essential to creating a simple and effective formula.
Determining the actual overhead is not such a daunting task. Here is a simple approach I gleaned from my mentor, Alan Revere, when I took his Marketing Designer Jewelry class in 1994.
Add all the costs of running your business (aside from labor and materials) divide that total by the number of hours worked to determine the overhead cost per hour.
(overhead / hours = cost per hour)
This approach is simple, direct, approachable and effective. It is best to figure out annual overhead cost because in many locations monthly expenses vary throughout the year, so the annual total of all expenses provides the most accurate result and is easiest to calculate.
The average expected full time work schedule in the US is 40 hours per week, 50 weeks per year. That adds up to 2000 hours for full time employment. Annual overhead divided by 2000 hours equals the overhead cost per hour to run your business. For every hour of labor, there is an hour of overhead cost.
It is important to accurately track the actual number of hours worked. If working part time or less than 40 hours per week, the overhead cost per hour is higher. Conversely, if working more than 40 hours per week, the overhead cost per hour is lower.
(This simple overhead cost analysis is based on an individual self-employed person with no employees. In the case of employees, divide the overhead cost by total number of employee hours to determine accurate hourly overhead cost per person.)
Simply put, labor is the time it takes to make each object. It is the hands on time of interacting with materials whether that is done entirely by the artist or done by employees or subcontractors.
Labor might also include design time, time spent on merchandising, packaging, display, administrative time, everything that goes into producing the completed work. In essence, labor is everything that is done to create a finished product.
Overhead is everything except materials (and labor) that goes into making the work. For each hour of labor, in house, there is an equivalent hour of overhead cost to provide the space and tools and equipment and infrastructure to be able to make the product.
Some people combine labor and overhead into a single figure in their pricing formula. That is an acceptable simplification – provided the annual overhead does not change from year to year.
For many of us, the overhead cost does change from one year to the next – utilities and taxes increase, costs of business supplies and services also tend to increase. For this reason I prefer to keep labor and overhead as two separate figures in my formula.
The starting formula is:
labor + materials + overhead = product cost
If you are not yet aware of what the actual overhead of your business amounts to, it is worth taking the time to figure it out, because, not doing that means you are just guessing what it costs you to be in business. If you file taxes, all the financial information you need is already there in your tax return; just add up the expenses and see what the real numbers say.
Now that our overhead is accounted for, we are still missing something – what about profit?
Is our business making a profit?
For a business to actually be profitable requires producing sufficient revenue to pay for everything it takes to make the work, and have something left over. If everything is paid for with the revenue generated, but there is nothing left afterwards, the business may be meeting expenses but it is not producing a profit.
There are two areas of profit for us to consider. First is material profit. As visual artists, in order to make our work, the first thing we have to do is invest in materials. Since we are making an investment, we should be able to realize a profit on our investment. Material profit is a markup or percentage above our actual cost of materials intended to generate a return on the investment we make in the materials we use.
Profit on investment is a simple enough concept, but there is a strategic component to material profit beyond just the return on investment. Material profit enables us to acquire new materials and increase our product inventory.
At the beginning of business start-up, most of us will find it necessary to reinvest some of our personal earnings (wages) into materials to make new work, but this is not a viable path to long term business success. Our wages are what fund our personal overhead. This is what we need to pay for our residence, our rent or mortgage, our food, clothing, transportation, health and wellbeing, insurance, taxes, and all of the other personal expenses of an adult human. If our wages also have to provide new materials to support growth in the business, the potential for perpetuating growth is very limited.
Strategic material profit is what enables us to fund growth by providing the ability to replace the material used in the items that have sold, and purchase additional material to make added items without relying on spending our wages to acquire new materials.
Thus the evolving formula is now:
labor + (materials + profit) + overhead = product cost
Here are some examples of application of simple markup percentages to fund growth in inventory:
33% material profit = every time 3 items are sold, they can be replaced with material for 4 items.
50% material profit = every time 2 items are sold, they can be replaced with material for 3 items.
100% material profit = every time 1 item is sold, it can be replaced with material for 2 items.
As is evident in the percentages, the higher the amount of material profit the quicker inventory can grow. But, the successful employment of this inventory growth strategy is wholly dependent upon one important factor – proper use of the material revenue. In order for this scenario to work the funds must be directed towards replacing the used materials, acquiring new materials, and creating new work.
Like many of the numbers we need to determine how much material markup or profit we can realize, this is an individual decision. This decision is affected by several factors: volume of sales, length of time the investment is tied up in materials before it turns over, amount of value added content in design and execution that goes into the transformation of raw material to finished product, the perceived value, price point and placement of the finished work in the marketplace.
The second type of profit to consider is business profit. In addition to covering all the costs of doing business and paying for materials and labor, overhead and expenses, there should be some additional revenue for a business owner and entrepreneur. If all that is generated is wages, without business profit, there is again little room for growth and perpetuation of the business. We may be employing ourselves but we are not profiting.
So, how can we determine what is an appropriate amount of business profit, and where can we include it in the formula? The first step is identifying our business goals and objectives.
To make the next forward movement a business might require any of the following:
- new tools or equipment to streamline process or increase productivity
- additional education or technical development
- hiring and training staff
- moving to a larger studio
- starting or expanding a promotional campaign
If we know we will need to buy a rolling mill, or take a workshop, or hire an assistant, we can assess the anticipated costs and factor them into our equation to help determine the amount of business profit required for the desired investment.
This takes projection forward to estimate the needs and plan the timeframe, and it also requires knowing the amount of the annual business revenue. Here is a hypothetical example:
Let’s imagine a new big ticket item such as a rolling mill or other assorted equipment will cost $2500, and we want to make the purchase within one year.
We will have to generate $2500 in business profit for our projected growth. We can proportion this as a simple percentage added to the product cost, determined by our gross annual revenue.
If annual revenue is $50,000 it will require adding a business profit of 5% to our pricing formula to generate $2500.
If annual revenue is $25,000 it will require adding a business profit of 10% to our pricing formula to generate $2500.
This is a simplified example, using a specific monetary objective as the determining factor of the amount of business profit needed in the next yearly cycle. There are other ways to assess what we need for sustained growth and development over the course of time. We might examine a three year or five year projection of growth and financial needs rather than just a single year. The numbers might also change depending on our business plan and short term or long range objectives. The important part is to get started by thinking about the next steps in the development of your business and what funding will be required.
The addition of business profit can be included as follows for our revised pricing formula:
labor + (materials + profit) + overhead = product cost
product cost + business profit = selling price
This pricing formula indicates a pricing strategy that accomplishes three important things for our business to grow and prosper:
- include overhead expense in our product cost
- provide a return on material investment to create new inventory
- provide a fund for business growth
Utilizing this formulaic approach provides a stable foundation to developing a reliable and accurate pricing system. Once you know the actual overhead expenses, material profit markup, and business profit margin, you can reduce the formula to a simple multiplier and incorporate the numbers any way that suits you.
The most important thing is knowing the numbers! Investing the time to figure out your own individual numbers is the very best investment you can make towards ensuring your business is priced for profitability.
Judging the Halstead Grant
Being the guest juror for the 2018 Halstead Grant Award was quite an honor and an opportunity I thoroughly appreciated and enjoyed. It was also a very enriching and illuminating experience to be a member of the judging panel and review and discuss the well prepared applications of so many talented jewelry makers.
The Halstead Grant Award is a very unique competition; it is far more comprehensive than judging finished pieces of jewelry against one another in an assessment based primarily on design and execution. The application for the Grant involves a highly detailed in depth examination of each applicant’s business, including not only design and execution but also their marketing plan, production capabilities, financial and growth projections along with an outline of how they would use the award resources to make their next step forward in business development.
Looking behind the design and execution of the work to all the other aspects of what it entails to be a professional visual artist is where the potential for success, or otherwise, really starts to show through. With a thorough examination of the finer details of a financial plan, areas of weakness become apparent and overall viability as a business becomes evident, or not.
Among many of this year’s applicants and finalists there was a common deficiency that I was inspired to address, one that is both crucial and essential to the prospect of success or failure as a business – this challenge lies in the issue of pricing. We’d love to hear your response to this article in the comments below.
For more pricing strategy and business tips, we recommend:
Michael David Sturlin is a renowned studio jewelry artist, goldsmith, writer, educator, and industry consultant. With over 40 years in the metalsmithing and jewelry industry, Michael has learned the ins and outs of not only jewelry making, but marketing your business and setting it up for success. He taught the Marketing Designer Jewelry class at Revere Academy for 10 years and hosts retreats at his Scottsdale studio each year. He recently served as the 2018 Halstead Grant guest judge.