Pricing

Background

A big part of choosing a target customer segment is knowing the price customers will bear. Offering the right recipe at a high price to customers with low disposable income is literally a recipe for disaster. On the other hand, selling cheaply to customers who would gladly pay more means the business is losing by leaving money on the table.  Knowing the right amount to price your burgers starts with understanding customer-perceived value and the operating and overhead costs of the food stand.

Customer-perceived value

Customer-perceived value is the importance or monetary value a person places on a product. It is what drives their buying behaviour. Suppose you are on a desert island in the middle of the ocean with no food or water. After two days you were asked to choose between a suitcase full of cash or a bottle of water. You will most likely pick the water bottle unless your last wish was to die holding a briefcase full of money. In that case, the customer-perceived value of the water bottle was much higher than the cash. An extreme example, but with a compelling point. 

From a customer's perspective, the value of a product changes based on the following:

The state and need of the person:

If a person is hungry, their value for food goes up.
During a pandemic, the value of toilet paper goes up. A point to remember; humans are the most complex species in the universe, right after the squid.

The monetary cost of the product relative to substitutes:

Unless the customer segment is price-sensitive, this does not apply. A product's price sensitivity changes with the level of importance consumers place on it relative to other criteria. Some people may value quality over price, making them less susceptible to price sensitivity. For example, customers seeking environmentally friendly burgers are typically less price-sensitive than bargain hunters. They are often willing to pay more for a burger that suits their preference.
A food stand similar to its neighbour but which sells the same burger recipe at twice the price of its neighbour has less value in the eye of most customers.

The availability and accessibility of the product through time:

Ever wondered why companies sell limited editions of some products? The marginal cost of making more of a product goes down, so why do they make only a few of them? It reduces availability and accessibility, thus making the product more valuable from the customer's perspective. 
Let's assume you produce only 20 burgers, your product quality is fantastic, and you are a famous burger stand. The customer-perceived value of your burgers will go up. Simultaneously, a time-sensitive customer might not want to come to your stand because of the uncertainty of getting food.

The quality of the product:

Quality is a subjective value and depends on the customer segment. A student might not differentiate between a burger with organic veggies versus a burger with regular veggies. The quality might be the same for this customer segment. However, they might feel that a burger with three slices of cheese is a better-quality burger than one with just one slice.

The global demand for the product:

Advertising increases the overall demand for a product because more people know about the business and what it sells. It helps create a brand to which people can relate and seek to associate by buying the product.
The more famous a brand, the more people talk about its product. This, in turn, creates more demand and increases the customer-perceived value.

Understanding the customer's buying behaviour helps determine if their purchasing decisions are based primarily on price or actual/perceived value. The business may subsequently target a high enough price to indicate quality and low enough to demonstrate value for money.

Simulation

Operating and overhead costs

Knowing the food stand's operating and overhead costs helps determine the minimum amount to price the food. If the price does not adequately cover expenses, the food stand will bleed cash and eventually go bankrupt. 

In the context of the simulation, operating and overhead costs are divided into:

Direct costs: Cost of goods sold, employee salaries, permit fees, etc.

Indirect costs: Marketing costs, cost of upgrades, etc
Interests: Interest paid on loans
Taxes: Business tax is different in every state/country in real life. Hence, it was removed from the simulation to reduce complexity.

Markup Pricing

Many food businesses use markup pricing to fix their sales price profitably. The simulation also uses it. It is a form of cost-based pricing where a markup percentage is added to the cost of menu items to arrive at their selling price.  The markup should cover operating and overhead costs and generate sufficient profits for the business. In this method, the menu item cost is multiplied by the chosen markup percentage to find the markup amount. Then the markup amount is added to the cost of the menu item to get the sales price.  

For example, suppose it costs you $2.35 to make each burger, and your markup percentage is 45%. The sales price is determined as follows:

unit cost price x markup percentage = Markup amount
$2.35 x 0.45 = 1.05 

unit cost price + markup amount = Sales price
$2.35 + 1.05 = $3.4

In real life, two cost aspects easily overlooked are wastage and the value of your time. Food businesses are renowned for wasting roughly five to ten per cent of their food and ingredients before it gets to the customer. 

While wastage can be limited, for a new entrepreneur still learning the ropes of the business, some waste is unavoidable. Planning for about 15% wastage is conservative enough during the early stage. This amount will drop significantly with practice, but the markup percentage should be reviewed to cover it.

Accounting for the value of your time is understandably not a straightforward matter. While earning a six-figure salary might not be your incentive for starting this business, you must plan for a reasonable income from the company. Resist the temptation to short-change yourself and ensure your markup sufficiently covers this. 