The Marketing Plan – Is your Product, at the Proposed Price, Profitable?

I know you could spit on yourself repeating the title of this article but the topic is important, extremely important, so we must proceed at the risk of spewing ourselves with saliva. The product characteristics have been determined. The product positions somewhere between to price points. The natural tendency is to price the product in the lower price range, but this may be a grave error. Even without a financial model profit margins can be determined. This is not a job for the technicians. They are excluded from the next step. The financial team is important and they must be added.

The first step is to determine the most obvious product costs. These are Cost of Goods Sold and generally include raw materials and labor. Sales or client acquisition costs must also be determined. If you have a production facility it is also important to understand how much a given product can be produced in a time period with stepping to the next level. This is because most production costs are like stairs. There is a basic cost to produce 1 piece of a product and the incremental cost is relatively small, then at some point of production the company needs additional employees, machinery, support staff causing a step like jump in cost structures and producing just one more piece will cause the cost structure to increase disproportionately. These steps will help determine the price point.

Here is the first objection, “Price and cost have nothing to do with each other!” Yes, this is true. Price is determined by demand while costs are, well, many other things. However, the demand is also determined by price, which is, at least theoretically, “if you increase price you reduce demand”, you can apply the price/demand model to your production cost structure and capabilities to find the optimum price point. Ah the counterintuitive dilemma, “selling more is not always better.”

So, the question arises, “Why should you care about this, all you want is for me to say the company is a good investment, the product has an addressable market?” The answer is simple, investments based on market share, number of clients, page views, are smoke and mirrors business models. They are kept primarily for publicly traded companies not for private equity. Private equity wants to know that you can get a certain return on the capital invested and that you can make money. Once I start looking at your product mix I will ask, “Why did you price your product where you did?” Your answer, and the way you arrived at that determination, will be an important part of my due diligence.

There are many good sites with a great deal of information about profitability and accounting. One I found by accident can help in determining if your product is profitable, the Bean Counters Site.

Tags: Small Business Private Equity Business Plans Financial Model Financing Marketing Sales Product Pricing