Is Your Price Right?
Is Your Price Right? Why Knowing Your Average Cost Matters for Local Businesses
If you're like most small business owners, you didn’t open your doors because you love spreadsheets—you opened them because you’re good at what you do. Whether you’re fixing pipes, baking cookies, grooming pets, or mowing lawns, you have a skill and a passion. But here’s the thing: even the most passionate entrepreneur needs to understand one key number to stay in business.
👉 Your average cost.
It’s not the flashiest topic, but understanding your average cost can help you make smarter pricing decisions, protect your profit margins, and position your business competitively in the local market. So let’s break it down.
🧮 What Is “Average Cost”?
Average cost is the amount it costs you to deliver a product or service, on average.
Here’s the basic formula:
Average Cost = Total Costs / Number of Units Sold
Let’s say you run a small coffee shop. Last month, you spent $6,000 total on ingredients, labor, rent, and supplies, and you sold 3,000 cups of coffee.
$6,000 / 3,000 = $2 per cup
That $2 is your average cost per cup. If you're selling your coffee for $2.25, you’re not making much profit. If you’re selling it for $4.00, you're doing better—but is your pricing in line with what customers will accept? Is it in line with your competitors?
These are the kinds of questions average cost helps you answer.
🧰 Why Is This Important?
Here are some ways tracking your average cost can help:
1. Set (or Adjust) Prices Confidently
You can't know if you're making money unless you know what it costs to produce what you sell. Many small businesses use “gut feel” or local competitor pricing instead of data—and that’s risky.
2. Benchmark Against Others
Are your margins too slim compared to other businesses in your industry? Benchmarking helps you see where you stand. (More on that below.)
3. Spot Cost Creeps
Prices for materials, rent, or services rise slowly over time. Without tracking average cost, you might not realize your profit margins are shrinking until it’s too late.
4. Plan for Growth
If you know your average cost, you can forecast future earnings more accurately. Want to open a second location? Knowing your cost structure gives you a solid foundation for that kind of decision.
📊 What’s a “Good” Average Cost?
It depends on your industry—but there are benchmarks.
For example, according to IBISWorld:
Full-service restaurants should keep cost of goods sold (COGS) under 30-35% of revenue.
Auto repair businesses often operate with a parts cost-to-revenue ratio of 25-30%, plus labor.
Retail clothing stores typically aim for a markup of 50-60%, meaning their average cost should be 40-50% of the sale price.
Beauty salons often spend 45-50% of revenue on direct costs (products, stylist commissions, rent).
The Small Business Administration (SBA.gov) also provides data sheets that outline profit margins and cost benchmarks by industry. If you're unsure where to start, these can be incredibly helpful.
🛠️ How to Figure Out Your Own Average Cost
Here’s a simple process any business owner can follow:
Step 1: Gather Your Costs
Include:
Direct materials (ingredients, parts, supplies)
Labor (wages for staff directly involved in production)
Operating expenses (rent, utilities, software subscriptions, insurance)
Marketing and admin (these can be spread out per unit/service)
Step 2: Define What a “Unit” Is
For a restaurant, it might be one entrée.
For a contractor, it might be one project.
For a salon, it might be one haircut or color session.
Step 3: Run the Math
Divide total monthly (or quarterly) costs by the number of units sold.
Pro Tip: Don't forget to include “hidden” costs like credit card fees, delivery charges, or product waste. These eat into your profit just as much as a faulty supplier does.
🧭 What to Do With That Info
Once you have your average cost per product or service, you can start:
✅ Setting Profitable Prices
Use markup strategies that reflect your industry, competition, and customer expectations. If your average cost is $50 and you’re charging $55, is a $5 margin enough?
✅ Testing Promotions
Can you afford to run a BOGO deal or a discount? Your average cost will tell you how low you can go without losing money.
✅ Identifying Efficiency Gains
If your labor cost is 60% of your average cost, can workflow changes reduce that? Is a supplier charging too much for materials?
✅ Tracking Over Time
Your average cost can—and will—change. Reviewing it quarterly helps you make real-time adjustments instead of reacting to problems after they’ve eaten away at your profits.
✅ Compare to Competitor Pricing
See how your pricing stacks up and whether your cost structure gives you an edge—or a disadvantage.
🛑 Common Mistakes to Avoid
Not updating costs when suppliers raise prices
Forgetting indirect costs like utilities or marketing
Comparing apples to oranges (e.g., comparing your prices to national chains without factoring in their economies of scale)
Assuming high prices = high profits (not true if your costs are equally high)
🌱 Final Thoughts: Knowledge = Power (and Profit)
If you’re running your business without knowing your average cost, it’s like driving a car without a speedometer. You might be doing just fine—or you might be heading for a costly mistake.
The good news? You don’t need to be a CPA to get a handle on your costs. Just start simple, keep it consistent, and use the numbers to guide smart decisions. However, the Chamber can hook you up with a great CPA too!