Turning a hobby or a craft into a business often has a fatal flaw with scalability. Say you have a business that produces 100 units that you plan sell for $25 and it costs you $20 to produce it. As a small scale business, you are happy with a $5 profit on each piece since you produce, pack, and ship the products yourself. However, there are many hidden costs that become visible when you scale up a business.
Imagine your product is well received in the market and your 100 units sell quickly. People are spreading the word about the great product you produced and more orders begin to flood in. A business calls you and they say that they love your product and want to buy one thousand units. You are feeling pretty good about yourself right about now. This is every entrepreneur’s dream… or is it about to become a nightmare?
Let’s take the analogy a little further to find out. The business who wants to buy one thousand units is sure your product will sell well. They are even expecting to place future orders. However, they want a volume discount on the order. With only a $5 profit margin, you have little room to negotiate a discount.
Furthermore, producing 1,000 products far exceeds your capacity as a one-man shop and you have to hire some employees to help fill the orders. Moreover, you now need insurance and perhaps even need to rent a bigger space. Since you have set the market price at $25, raising the price will be difficult and you have no margin to handle scaling up. Thus, the nightmare begins.
To avoid this problem, I often tell people that as a general rule you should price your product at least 2.25 times your costs. To illustrate why you should price your product at 2.25 times your costs, let’s do some math. Let’s assume it costs you $20 to produce the product. You should get at least 50% in operating margin to cover your expenses, such as your salary, rent, profit, etc. 50% of $20 is $10 in operating profit, which means your wholesale product should cost $30. However, if you sell to a retailer, they will need at least a 50% operating margin themselves to cover their operating costs. With a wholesale price of $30, 50% is $15. This means the retail price should be $45. To put it more simply, $20 (your cost) times 2.25 equals $45.
Are you pricing your craft or hobby products at least 2.25 times your cost to produce it?
