How To Understand Your Startup Costs

Every time I work with a new business prepping to pitch, I ask:

“What question are you afraid of?”

Nine times out of ten these dreaded questions from the audience or investors are around costs, pricings, and financials.

Many times, founders may not have the same academic or professional background as an accountant. And this is okay, but it is important to justify your assumptions with your business pricing. (Especially if you are pre-revenue.)

I broke these concepts down using some simple ABCs, so an individual can parse through their costs into more manageable chunks. Then, there can be more certainty both in profitability and confidence in these critical conversations.

Meet Asha

To make this more relatable, let’s create the example of a founder in a product-based business. Her name is Asha, and she is a local London woman who is known for her delicious, family-created recipes. After investigating that this is a need in the market, she has decided to start a monthly recipe subscription kit with her unique spice blends.

Now, let’s jump into the costs:

A → Actual Costs

Think of all the actual costs you incur. What does it physically take for you to produce one unit of your product? I like to think of this as the tangible materials like bioplastic, paper, etc. as well as time it takes to create your product.

In the case of Asha, this would include raw materials like her spices, the containers, paper for recipe cards, and packaging, as well as her promotional flyers in each box, shipping (if it is not paid separately), and her time to make each order.

B → Build in your Margins

What separates a business and a hobby is sustainable profits; to do this, there needs to built-in profit margins. Profit margins will keep a business healthy, with some industries having over 40% whereas others may have as little as 10% in the beginning.

For guidance, there is a website that helps break down the average profit margins for respective industries.

In Asha’s case, we can see that the average gross profit margin is 25%, but because of her user research and willingness to pay, she decides to have an approximate profit margin of 20%.

C → (More) Costs

When you think there aren’t any more costs, there are always more!

Fixed costs: Fixed costs are your overheads and costs you undertake no matter how many products you create. No matter how many subscription boxes Asha sells, she will still need to account for things like her designer, the IP costs, and her storage unit.

In the case of Asha, she has relatively low fixed costs:

There can be more costs that are hidden from your initial projections such as:

Commission programs: Commissions are something that are to be considered if they are implemented in their business. Asha may partner with a local restaurant who gets a 5% commission from every box they sell. This will be a cost that Asha should incorporate in either her product stream or marketing budget.

Time = money: Often times, founders forget that their time should also be baked into the price of the product sold. For example, Asha can create 15 boxes an hour, and this time needs to be woven into her customer’s price. (Lucky for us, we already thought about this in the variable costs!)

D → Don’t (immediately) Discount

Founders often undercut their prices significantly in the beginning to get traction. Though this can work, discounting can create cashflow issues in the long term. It is easier to discount later when economies of scale are on your side than in the beginning where every order matters.

When thinking about pricing and discounts, it is also wise to think about your breakeven analysis, which is the total number of units where your costs equal your revenue. This is a good indicator of when your business will become profitable.

For example, with Asha she will breakeven after 122 boxes, and her current email newsletter list is over 1,400 subscribers. This means she will need about 9% of her newsletter list to buy every month to breakeven.

E → Evaluate the Market

What is the market rate for a product like yours? Remember the benefits that you are providing to your users and the price they would be willing to pay for these. In the case of Asha, spice and food kits vary significantly. Businesses like Spice Madam charges $20 a month for US customers, and in the UK, the Spicery charges $26.

Asha is at a reasonable price point for her clientele, but she can adjust as needed. Having a customer user group or survey can also help with the accuracy of these estimates as well.

Asha will need to continue to research her direct competitors as well as her indirect competitors like the local restaurants, spice stores, or even Deliveroo. (Because sometimes, you have all the good intentions to cook and no time!)

Additionally, she can refer back to her early testers to evaluate the value and benefits within her spice kits.

Now, my goal is to not make you hungry with food looking this good! But I wanted to share with you an example (and you can use the template here if you make a 'Copy' from Google Sheets) This is just to get a preliminary understanding of some key elements to think about when working through pricing, especially if you have never embarked on it before.

Though this is not a comprehensive list, yourself, like Asha, can draft out all your costs (and potential recipes!) to work through.

I'd love to hear your thoughts. How have you worked through understanding your business costs?

WHAT TO DO NEXT:

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