The Flaws of Using the Keystone Pricing Formula
From time to time, I work with clients who struggle with coming up with an appropriate pricing formula. A common method I see them using sometimes is simply setting their retail price to be double their cost of goods, also known as the Keystone Pricing Formula.
The Basic Formula
Keystone pricing is quite easy to figure. You begin by determining your costs of goods sold (COGS). It’s important that you realize ALL of your costs. Let’s say for instance I sell custom designed business shirts. I design them at home, but I have the shirts manufactured through Zazzle.
I’m going to use some arbitrary numbers. Let’s say the shirts each cost $5.00 as the base price. However, it costs an additional $10 to ship 10 of them. So, 10 shirts will cost me $5 X 10 = $50 + $10 shipping, for a total of $60. To get my COGS per shirt, I divide the number of shirts by my total cost, $60/10 = $6/shirt. There you have it. My COGS per shirt is $6.
To get your keystone price, you’ll double your COGS, which will give you $6 X 2 = $12. This means, you’ll sell your shirts for a retail price of $12. Easy as pie, right? So what’s the problem with using that formula?
Pricing Is Not One Size Fits All
Using this pricing model may result in you setting prices too high or low. Let’s go back to the shirt example. If your competition is successfully selling similar shirts to yours for $15, you’re leaving money on the table. So, what it’s $3 bucks. Well… $3 adds up when you start talking bulk. If your motto is on the lines of sell low = higher quantities, I encourage to rethink your pricing strategy. For one, there is always someone who can come along and underprice you. Don’t turn it into a game of how low can you go. Secondly, too low of a price, and you might not even make a profit. I encourage you to play with the break even calculator. Try out different pricing models and see how they might affect your bottom line.
On the other hand, you can also price yourself right out of business with too high prices. Back to those shirts. Instead of the shirts costing you $5 each, now let’s say they cost you $9 each plus $10 shipping for 10. Using the same math as above, your shirts are going to cost you $10 each. Multiple that by 2 for the keystone pricing and you retail $20 per shirt. If you have no way to differentiate your business from the competition, $5 is a pretty big difference when sizing up shirts side by side.
Research, Research, Research
Rather than arbitrarily markup your COGS by 100%, I encourage you to research your competition. Go into their stores and look around. If you have to, send a secret shopper. Find out what the going rate is for your area. Chances are, your competition has been around long enough to establish a decent pricing model. Take advantage of their hard work and put it to practice in your business.
Don’t just stop at the competition. Also research the industry standards. Who knows, maybe your competition has gone about their pricing strategy the wrong way. The industry standards can help you settle on a more realistic pricing standard, rather than putting yourself in a situation of the blind leading the blind.
Know Your Break Even
And finally, know your break even. It doesn’t matter what your competition is doing or what the industry standards are. If you can make your price profitable for you, you’re going to have to rethink your pricing strategy.