Last time I discussed different options of determining the sales projections of your start up business. When talking sales, it's all down to volume and price. So let's have a look at the pricing today. Do you have any idea what average price will you charge to your customers? Or how that price will change in time? That's an ultimate question for your start up and your financial model so let's get it right first time.

There are numerous pricing strategies out there that relate to your strategy, competition, product positioning, discounting, bundling, customer loyalty, quality, etc. But for the purpose of the financial model for start-us, let's narrow it down to 2 basic pricing strategies:

1. Cost-plus method, or inside-out

In this method you set your price by taking into account your cost base and desired profit. So you determine how much will it cost you to produce and sell the product and determine how much you want to make on top of that. Your price calculation can look somewhat like this:
Material costs: $10
Labour: $5
Overhead: $3
Other costs: $2
TOTAL Costs: $20
Desired profit mark-up: 10%
Selling price: $20 + 10% = $22

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2. Competitive pricing, or outside in

In this method you determine your price by looking at the prices of your competitors. You can calculate the average competitive price or set the price close to your major competitor. Then you need to work backwards to determine what is the maximum cost ceiling to remain competitive and profitable. The calculation can look like this:
Competitive price: $20
Desired profit: 10%
Maximum costs: $20 * 90% = $18

Should you bother with price changes?

You are building your financial projections for 3 to 5 years. Sure the price can change over that time period and by incorporating the price changes into your financial model you will make it more credible. However, many financial models simply ignore the inflation altogether. So should you bother with price fluctuations over time? Well, it depends. It depends on your business. Let's say you plan to open a pizzeria. You set the price based on your competition. Is the price of a pizza likely to change in next few years? Probably not very significantly other than by inflation. But what if you are a technology start up with a new innovative product? In that case, you will probably charge a high price in your first years, since the market will be immature, there will be no competition and you will need to recover high R&D costs. But in a few years your price may drop dramatically as new competition will enter your market and you become more cost efficient. In that case, price adjustment in time is necessary.

So remember, set your price reflecting your cost base and competition, and consider incorporating the price inflation (or deflation) into your model. Be realistic and conservative, because your potential investors will challenge your assumptions. And you don't want to loose your credibility at the very first line item in your model. Check out the Sales projections worksheet in Feanut Financial Model to see how it allows the price changes to be reflected in the model.

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