FACT SHEET: Part 5—Setting Prices

Don't just take a price, make your price!

By Michelle Frain, Marketing Coordinator for the Rodale Institute and Christine Ziegler, Editor

Posted June 23, 2005

	“Pricing may be the most misunderstood exercise in all of marketing.” --Dana Blankenhorn, of MarketingProfs.com.

BASIC PRICING FORMULAS

In order to make a basic profit, you can stop at Step 3. However, your profits will increase as you use each additional step, from wholesale to retail to organic. By going to Step 4 and beyond, you stop paying a “middleman” and start making and keeping more profit for yourself.

Cost per unit = (Materials + Labor + Overhead)/Number of Units Produced
Example: $20 per box of tomatoes = ($50 for equipment and amendments + $150 for labor + $300 for overhead)/25 boxes

Profit = Price per unit – Cost per unit
Example: $10 per box profit = $30 per box selling price – $20 per box cost or
Mark Up (%) = Price per unit ÷ Cost per unit
Example: 50% mark up per bushel = $30 per box selling price ÷ $20 per box cost

Wholesale Price per unit = Cost per unit + Wholesale Profit per unit
Example: $30 per box wholesale price = $20 per box cost + $10 per box profit or
= (Cost per unit) x Mark Up %
= ($20 per box cost) x 50% mark up—provides a $10 profit per box

Retail Price per unit = Wholesale Price + Retail Profit per unit
Example: $40 per box retail price = $30 per box wholesale + $10 per box retail mark up or
= (Wholesale Price) x Retail Mark Up %
= ($30 per box wholesale) x 33% retail mark up—provides a $20 profit per box

Organic Price Premium = (Direct Market Retail Profit) x Organic Mark Up
Example: $45 per box organic price = ($40 per box retail price) x 12.5% organic mark up—provides a $25 profit per box

Total Organic Profit = Profit from Organic Premium + Organic Production Cost Savings
Example: $30 profit per box = $25 per box profit from organic premium + $5 per box cost savings from reduced input purchases (balanced with increased machinery and labor costs)

These pricing formulas outline a clear path toward your price and profit goals. If you sell wholesale (to a broker or auction, for example), you can simply stop with Step #3. However, if you sell your products directly to your consumer at or near retail prices (direct marketing), you’ll need to use Step #4. As a retailer, you can usually double (or apply a 100% mark-up to) your wholesale price, but you can multiply that by even more for organic or value-added products.

The mark-up for organic or value-added products is commonly referred to as a price premium. Price premiums vary depending on the quality and availability of the product, but research shows that organic and value-added products can fetch anywhere from 25-200% more than their equivalent conventional products (a recent brief survey of the Organic Price Index showed an average 80% price premium for organic fruits and vegetables).

Any time you change the numbers you plug into these formulas, you will affect your final profit. For example, you can increase your profits without increasing your prices by looking for areas where you can reduce your costs.

Good pricing can be summed up, in large part, as the art and science of creating a win-win situation: though neither the farmer or customer gets “the most incredible, amazing price”, both come away feeling that they exchanged quality products for a good price. While experts disagree about what pricing strategies are best, many preach the price floor/price ceiling strategy: calculate your lowest break even price (price floor) and determine the maximum price a customer is willing to pay (price ceiling).

Your price floor is easy to define when you have calculated your costs (see Part 4 – Creating an Enterprise Budget, as well as the formulas above). Your cost per unit tells you the price floor you need to charge customers in order to break even. If you are not able to sell your product at its price floor, try to think of creative ways to transform or add value to your product, rather than sell it below cost. For example, you can make sauce or salsa out of excess tomatoes and peppers, or dry and bunch some of your corn cobs to transform an inexpensive food product into a more lucrative decoration.

Finding the price ceiling for a product takes more time and experimentation. Most farmers master this skill through good old fashioned trial and error, modifying their prices and products in response to customer demands, and adapting to changing customer preferences over time (both at the wholesale and retail level). To get started, you can use tools like the Organic Price Index to find current produce and commodity prices (both organic and conventional) from around the country (mostly wholesale, taken from terminal markets). Or you can go to area farmer’s markets and supermarkets to scope out local prices, as well as hot products. Either way, finding a healthy price ceiling takes some time, but the extra time can generate some healthy extra profit!

Customer psychology is also an important aspect of pricing that we address in Parts 6 and 7 of this series, as well as in the fact sheet “Direct Marketing: A Shorter Road to Higher Profits”.

Ethics and pricing

Trust your instincts: if a practice “feels okay”, you have confidence in it, and wouldn’t mind your neighboring farmer doing it, then it's probably ethical.

	"“Don’t shoot yourself in the foot. If you have extra product, keep selling it at the same price, then wholesale it, but do not sell it for less at the farmers market. You undercut your neighbors, and now everyone has to reduce prices and make less money.” --Don Kretschmann, Organic Farmer Beaver County, Pennsylvania

Ethics are the cornerstone in the foundation of an effective pricing plan. Just as good production practices (such as efficient management) can sustain your farm’s resources and add value to your products, good ethical practices (such as progressive labor management, value-based marketing, and positive community partnerships) can sustain your business, add value to your products, and improve the lives of you and your customers.

Agricultural pricing ethics are hard to define. However, ethical mistakes are easy to identify once they have been made. You can probably cite an incident in which someone you know has made an ethical mistake in product pricing, upsetting neighbors and alienating customers. These people often grow to regret their questionable business action, even if the action was financially profitable.

The most critical rules of ethical pricing are:

1. be aware,
2. be considerate, and
3. look beyond the bottom line. Think of the long-term sustainability of your actions.

For example, most farmers understand that it is unethical to dump a surplus product on the market at rock bottom prices. Many big business retailers do this (as do some large farms), but for small and mid-size farms, this practice can have terrible consequences. Your neighboring farmers will be forced to lower their prices, they will resent your action, and, in the end, everyone will lose money and good relationships.

If you are not sure about the ethics of a certain business plan, ask someone you trust. A good second opinion could save your reputation and future financial viability. Also, trust your instincts: if a practice “feels right”, you have no doubts about it, and you wouldn’t mind if your neighboring farmer did it, then it is probably ethical. If your idea doesn’t pass all of these “gut checks” (especially the last one), then you should probably reconsider it.

For more information on prices, pricing formulas, and related issues, please consult the following resources.