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Do You Know Your Exact Product Cost? Here’s How To Find It!
Do you want to understand your product cost, so you can make better pricing decisions?
Every business is worried about product costs. The first thing customers ask when purchasing something is, “What does it cost?”
It is important to understand your exact product cost so that you can provide your customers with fair, competitive pricing that sets you up for maximum sales success.
So what IS total product cost, exactly?
The product cost includes more than what you paid for the product.
It also includes the cost to ship the product to you and/or the warehouse, the cost of taxes, the cost of storage, the cost of selling on various platforms or in stores (like Amazon FBA fees or store fees, if any), the cost of labor to manufacture the product, and the cost to ship it to the customer. All of these included costs are what make up your TOTAL product cost.
Depending on your individual type of product, you will need to add in all the other costs from your supply chain, from start to finish.
These include costs like setup, shipping, actual product, packaging, shipping supplies, freight, taxes and duties, and more.
But don’t worry, this might seem like a LOT to figure out, but we will examine these more closely below.
Why is the total cost important?
Understanding the total cost of your product is an important part of calculating your actual profit. In business terms, the total cost is the baseline of where your profit can begin.
If you can’t sell the product or service for more than the total cost, you won’t make any money, and will soon go out of business.
The profit starts right after you have made up the total cost of the product or service. Simply put, it is the amount of money you get to KEEP after the sale is completed.
Ok. So how do I calculate the total cost of my product?
Calculating the total cost is very simple.
The problem most business owners run into is actually not the calculating, it’s actually remembering every step of the supply chain process.
No magic math tricks are required to figure out your total cost- you just need to add and divide, stuff you learned in middle school and use every day.
The best way to calculate the product cost is by working backward through the supply chain.
Starting with the customer, work your way all the way back to the first step of manufacturing the product or start of the service.
At each point, you will find a cost that you had to pay. (We will look at some examples of these below.)
As you go through the process, write each cost down on a piece of paper (or in a spreadsheet).
Once you write down all of the costs at each step, you just add them all together, and this will give you your total cost.
Voila! See, I told you it was simple.
Now that you’ve got the basics down, let’s take a look at some different scenarios that might make this process a bit different:
How do I calculate the total cost if some parts of my product are priced in bulk?
Sometimes, we buy our product (or parts of it) in bulk, or in multiples. For example, we might buy a case of 50 boxes to package your product in, and a case of 100 label sticker sheets to put labels on the boxes.
When this happens, you just need to find the individual unit cost, so the cost of ONE box or ONE label.
So if a case of boxes cost $48, and comes with 50 boxes, it would look like this:
$48 / 50 = $0.96 per box
You will do the same thing for all of the parts in the supply chain.
What if I have marketing costs?
These days, most businesses have marketing costs, especially online (or social media) marketing.
In this article, we will not add the marketing cost to your total cost. We will save that for another article.
We don’t want to worry about this right now, because there are many different ways to calculate and include marketing expenses.
For example, you might run 4 different facebook ads, three of which market one specific product, and one which directs viewers to your storefront. To add that to your individual product cost would be quite complicated (and often unnecesary).
Instead, you can put marketing expenses in your running (also known as operating or overhead) costs, such as the office rent or your internet bill, and then subtract it weekly from your final profits.
How does knowing the total cost of my product or service help me and my business?
Once you know the total cost per unit for your product, you can use this to decide what to sell your product for in order to make a profit.
The selling price needs to be above the total cost in order to make a profit.
The higher you price the product or service, the more profit you make after subtracting your total cost.
But don’t price your product too high, because you still want to be competitive to your market and fair to your customers so they will return again.
What are some of the things I should include in my total product cost?
- Inbound Shipping Cost
- Taxes and Duties
- Storage Fee (Like Amazon storage fee)
- Handling Fees (such as Amazon FBA fee)
- Shipping Material
- Outbound Shipping (to the customer)
- Setup Fees or Design Fees
- Transaction Fees (if selling online)
Now that you’ve stuck with me for this entire explanation (and hopefully you’ve learned some good stuff!), let’s take a look at some examples of different types of products/services.
Total Cost Example with a Coffee Shop:
When I was 18 or 19, my parents owned a small coffee shop that I helped manage.
We had no idea what we were doing or how to charge for our coffee, pastries, etc. We knew we wanted to be cheaper than Starbucks, so that’s what we did. After a short while, however, we realized we were making no money.
We sat down to figure out where the problem was: we weren’t including ALL of the costs!
So we broke it down, step by step:
We bought our coffee in 5lb bags for $15.00 a bag. We could get roughly 200 espresso drinks from this bag.
Next, we had to get cups and lids. This came in a case of 1,000 each. The lids were roughly $24.00 for a case, and the cups were around $28.00.
The delivery for these goods was a standard $25.00 delivery fee each time.
The milk for the lattes was $2.00 a gallon. Each gallon lasted for about 20 espresso drinks.
This is how we broke down as our cost for the basic medium-size latte.
We had about 40 different types of drinks, and we did this for all of them.
If you have noticed the problem already, don’t worry, I will get there soon.
The total cost was $0.252 per drink.
You might be thinking WOW!! That is a low price!
Yep- it’s a great price, and since we charge $2.00 per latte, we brought in a profit of $1.748 per drink. Woohoo!
We did not calculate any of the other products we had to buy or use to make and sell each latte:
- The cost to operate the espresso machine per drink
- The cost of paying the employee to make the drink
- The cost of the rent of the shop location
- The cost of the sugar customers added to the drink
- The cost of water used for cleaning the machinery, dishes, tables, etc
- The cost of soap
- The cost of paper towels and napkins
- The cost of electricity to run everything
- The cost of providing internet to our customers
- The cost of toilet paper in the bathroom
And the list goes on and on and on. NONE of this was factored into our cost for the coffee drinks.
And unfortunately, we didn’t have the ability to google articles on how to figure out our profits. It was a solo mission, and we learned as we went.
But eventually, we did learn a valuable lesson on product cost.
So please, by all means, learn from our mistakes!
An easy way to account for costs like this is to take the total amount you spent on costs like these and divide it by the total number of things you sold.
This would be your total product cost.
In our case, the total cost came to almost $3.00 per latte, when everything else was factored in.
When you measure your total product cost, you need to account for all of the little things as well- or you will close your doors a lot sooner then you might have wanted.
Total Cost Example with an Amazon Product:
Amazon is a great place to sell products and build a brand. But it does get competitive, and cost plays a HUGE factor in whether you make a profit or not.
Selling a product on Amazon is relatively easy, but having the right price can get a little tricky.
The first step of your pricing strategy needs to include an accurate product cost.
In this example, we’re selling a universal travel bag for $20.00. It’s perfect for holding all your kid’s stuff, so it is often purchased as a diaper bag, despite being a basic (but awesome), all-purpose bag.
We have these bags manufactured from a wonderful little warehouse in China. They handle all of the packaging, and ship it right to the Amazon FBA warehouse, complete with Amazon’s required labeling.
We want to sell it for $20.00 to stay competitive in the Amazon marketplace.
Let’s take a look at our basic costs:
- The manufacturing cost for the bag is $1.50 per 300 units.
- Adding our branding tag to the bag is $0.15 per tag
- The UPC cost is a $2.00 flat fee, purchased once.
- The shipping fee to the warehouse is $300 per order, which includes duties and taxes.
- Amazon takes a 15% commission per sale, which totals $3.00 per unit.
- They also charge an Amazon FBA fee of $4.19 per unit (and includes shipping the product to the customer).
- Amazon charges $39.99 per month to use its marketplace to sell your products.
- And Amazon charges $0.30 per unit for monthly storage for each product.
** These numbers are just guesses and can fluctuate by product, category, etc. I recommend reviewing all current pricing associated with Amazon FBA by visiting their site here**
The total unit cost for this amazing not-a-diaper-bag-so-your-husband-might-actually-carry-it bag is roughly $10.28 per unit.
This gives a total profit of $9.72 or a profit margin of 48.6%.
Of course, this does not include advertising costs on the platform. Ideally, ad costs (or pay-per-click advertising) should be included in your cost.
Just like marketing costs, that gets a bit more complicated (and is beyond the scope of this article) to figure out.
In reality, getting a 48.6% profit margin on Amazon is extremely hard when you first start out. If you can bring in a profit margin above 25% (after all costs are included, including advertising), you’re in pretty good shape compared to most Amazon sellers.
We’re also going to be writing more articles about how to create products with higher profit potential and better success rates, so make sure to check back often!
Understanding your total product cost is CRITICAL to your business.
It is not as simple as buying something for $5.00 and selling it for $10.00. This might work for a one-time purchase or sale, but to grow your business effectively, you will need to understand your total cost.
There are many resources on how to figure this out, but the best rule of thumb is to write down anything that you paid for, add that together and divide that by the total number of units you sold.
If you have any questions, please comment below! There’s so many different types of products and services that it’s hard to encompass in a single article, but this should be a great jumping-off point for you to get the ball rolling.
Congrats! You’re ready to sit down, figure out your own total product cost, and set your business up for maximum success.