The Magic Pricing Formula

One of the most common business-related questions I see regarding starting a new bakery is how to price your products and services. If you can legally charge for food in your area with your current setup (for example, some states restrict home bakeries), the answer is a simple formula:

Price = Ingredient Cost + Labor Cost + Allocated Overhead Cost + Profit

To price ingredients, you need to to know how much you are spending per unit on each ingredient and how many units of each ingredient are in your recipe.

Your labor cost is based on how many hours it will take to complete the order (including prep, baking, decorating, packaging, and cleanup) multiplied by your hourly wage. If you rent a commercial kitchen by the hour, I find it’s convenient to capture that cost under labor since it is directly related to the time spent on order processing.

Your total annual overhead expense is how much you are spending per year on stuff that’s not directly related to creating products but is still necessary to run your business, such as insurance, accounting, license fees, utilities, advertising, etc. To find the allocated overhead cost, just divide your annual overhead expense by the number of orders you fill per year.

The first three items added together represent your cost. The last component, profit, will typically be a markup in the 15-45% range. To determine how much to mark up your cost, you need to do some market research to see how much similar products are selling for in your area. If you find that your cost is already higher than market value before applying markup, you need to reduce your costs, find a new market, or both. Do not try to price your products below market value.

This magic formula can be applied to just about any product or service. Of course, the formula’s accuracy is only as good as your data, so be diligent and make sure to revisit your pricing structure every year or so to account for inflation.

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10 thoughts on “The Magic Pricing Formula

  1. Jason! Such a great idea to start this blog. I’ve got my eye on this space and I know your content is going to be top-notch. I’m so glad I now have one link for the 9,000 pricing questions that pop up every day. Thumbs up!

  2. Pingback: Starting a New Business | The Bakery Business Perspective

  3. Pingback: More About Allocated Overhead | The Bakery Business Perspective

  4. Met you on cakecentral, trying to get my business going and I had soo many questions about pricing. Thanks for posting and when I have the extra money, definitely donating! (:

  5. Jason, I can’t believe the issue about cake central. Your information is top notch and I will make sure to keep up with your blog, you are the reason why I started going to cake central … in order to read your comments. I wish you the best of luck and I will keep in touch 🙂

    Best Regards
    Elizabeth Houde

  6. Hi Jason! I was wondering if you could take a look at my product and if you like it recommend it to others. My Mom has a successful home based cake business and was looking for an inexpensive tool to manage her orders, price her cakes, and keep track of her expenses. I designed her a personalized Microsoft Excel Tool and I would like to sell it to others as an alternative to pricey software that’s out there.

    Thanks,
    Josie

    • I checked the link you sent me and based on the screenshots it looks to be a pretty good tool. In terms of monetizing it, converting the tool into a hosted web-based service with mobile access might expand your potential customer base.

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