Few decisions touch profit as directly as pricing, and it's often made with very little information. A price gets set when the product launches, by adding something to the cost or by looking at what the shop down the road charges, and then it stays there, slowly eroded by rising costs, until the business is working harder every year for the same profit.
What I want to do here is build up the few ideas you need to price deliberately. They're simple individually. The value is in seeing how they connect.
First, it's worth seeing how prices drift too low, because it usually happens through a chain of reasonable steps. A price gets set at launch by adding something to the cost. Costs then rise a little at a time, each rise too small to feel worth a price review. Meanwhile there's a fear, never tested, that any increase will drive customers away. Each step is understandable. Together they produce a business that sells more and keeps less, without anyone having decided it should.
Margin and markup are two different numbers
Let's start with the confusion that causes the most underpricing.
Say a product costs you LKR 1,000 to make or buy, and you sell it for LKR 1,500. You make LKR 500 on each one. There are two ways to express that LKR 500 as a percentage, and they give different answers.
Markup compares the profit to the cost.
LKR 500 ÷ LKR 1,000 = 50% markup.
Margin compares the profit to the price.
LKR 500 ÷ LKR 1,500 = 33.3% margin.
Same product, same price, same profit. A 50% markup is a 33.3% margin. Margin is always the smaller number, because the price is always bigger than the cost.
Here is why it matters. Suppose you decide you need a 40% margin to run the business. If you add 40% to the cost, LKR 1,000 + 40% = LKR 1,400, you have applied a 40% markup. Your margin is LKR 400 ÷ LKR 1,400 = 28.6%. You've priced yourself more than eleven points below where you meant to be, on every sale, without noticing.
To hit a target margin, divide the cost by one minus the margin:
Price = Cost ÷ (1 − target margin)
LKR 1,000 ÷ (1 − 0.40) = LKR 1,000 ÷ 0.60 = LKR 1,666.67
Check it: LKR 666.67 profit ÷ LKR 1,666.67 price = 40%. That's the price that gives you the margin you planned.
Gross margin and net margin answer different questions
The margin above is a gross margin: what's left from each sale after the direct cost of the thing sold. It answers the question "is each sale worth making?"
But the business has other costs that don't belong to any one sale: rent, salaries, electricity, marketing, accounting, loan interest. Those are your overheads. Net margin is what's left after all of them. It answers a different question: "is the business, as a whole, worth running?"
A month for a small retailer might look like this:
| Sales | LKR 2,000,000 |
| Cost of goods sold | LKR 1,200,000 |
| Gross profit | LKR 800,000 (40% gross margin) |
| Overheads | LKR 650,000 |
| Net profit before tax | LKR 150,000 (7.5% net margin) |
Both numbers are useful, and they move for different reasons. If gross margin is falling, look at your prices, your suppliers and your discounts. If gross margin is healthy and net margin is thin, look at your overheads, or at whether you are selling enough volume to carry them.
How much you need to sell to break even
Once you know your gross margin and your overheads, you can work out the sales you need just to cover your costs.
Break-even sales = Overheads ÷ Gross margin
LKR 650,000 ÷ 0.40 = LKR 1,625,000 a month
Below that, the business loses money. Above it, every extra LKR 100 of sales adds LKR 40 of profit. This one number makes pricing decisions much clearer, as we'll see in a moment.
If you charge VAT, take it out first
If your business is VAT-registered, the price your customer pays includes VAT, and the VAT isn't yours. At the standard rate of 18%, the LKR 1,666.67 price above becomes LKR 1,966.67 to the customer, of which LKR 300 goes to the Inland Revenue Department.
So always calculate margins on the price before VAT. A business that works out its margins on VAT-inclusive prices will think it's earning more than it is.
Three reference points for setting a price
There are three common ways to set a price, and each one tells you something real. The mistake is using just one.
Your costs give you the floor. The price has to cover the direct cost plus a fair share of overheads plus profit. Below the floor, every sale makes you poorer. Cost-plus pricing is a good way to find this number, and a poor way to set the final price, because your customer doesn't know or care what something costs you.
Your competitors give you context. They show you what customers are used to paying for something similar. But matching a competitor's price assumes their costs, their positioning and their margins are the same as yours, and you can't see any of those.
The value to your customer gives you the ceiling. What is the product worth to the person buying it? A same-day repair is worth more than a next-week repair to a restaurant that can't cook without it. A cake for a wedding is worth more than a cake for a Tuesday. The ceiling is set by the problem you solve and the alternatives the customer has.
Your price should sit somewhere between the floor and the ceiling. Where exactly depends on how clearly you've shown customers the value, which is a positioning question as much as a pricing one. The better a customer understands why you're the right choice, the closer to the ceiling you can price.
Discounts and price rises are not symmetrical
This is the part of pricing that's rarely worked out on paper, and once you see it, it changes how you think about both.
Take a product with a 40% gross margin. For every LKR 100 of sales, LKR 60 is cost and LKR 40 is gross profit (sales minus the direct cost of what was sold).
Now offer a 10% discount. The price drops to LKR 90. The cost stays at LKR 60. Gross profit falls to LKR 30 per sale, a quarter less. To earn the same total gross profit as before, you need to sell a third more units (40 ÷ 30 = 1.33). A 10% discount needs 33% more volume just to stand still.
Now raise the price by 5% instead. The price goes to LKR 105, the cost stays at LKR 60, and gross profit rises to LKR 45 per sale. You could lose about 11% of your volume (40 ÷ 45 = 0.89) and still earn the same gross profit as before.
So at a 40% margin, a small price rise gives you a lot of room, and a small discount needs a lot of extra selling. The lower your margin, the more extreme both effects become. That's worth holding in mind every time someone suggests a promotion.
Does that make sense? Here's an everyday way to feel it. Imagine you sell king coconuts at LKR 100 each, and each one costs you LKR 60. You keep LKR 40. Sell one for LKR 90 and you keep LKR 30, so you'd need to sell four coconuts to make what three used to make. Sell one for LKR 105 and you keep LKR 45, so you could sell a few fewer and still come out ahead.
Your best-selling product may be your least profitable
Most small businesses sell more than one thing, and the margins differ from product to product. It's common to find that the product everyone buys, the one you're known for, carries the thinnest margin, because it's the one where you've felt the most price pressure.
Make a simple table: each product, its price before VAT, its direct cost, its gross margin, and how many you sell a month. Then sort it by total gross profit. The order is often surprising. Some products are carrying the business; others are taking up time, space and cash while contributing little. That table tells you where a price rise matters most, which products to promote, and which ones to rethink.
Keeping prices current
Costs rarely stand still. Suppliers raise prices, the rupee moves, wages and electricity tariffs change. A price set two years ago against two-year-old costs has usually lost some of its margin without anyone deciding it should.
A useful habit is to review your margins every quarter, product by product, and to plan small, regular price adjustments over rare, large ones. Customers adjust to modest regular changes more easily than to a sudden jump, and the business never drifts far from the margin it needs. When you do raise prices, tell your regular customers in advance, and tell them why, plainly.
Three attitudes to price
The first is to match whatever competitors charge. It feels safe, and it hands your margin to whoever has the lowest costs in your area.
The second, after a price war or two, is the belief that customers only care about price. Some do. Many care about speed, reliability, convenience and trust, and pay for them every day.
The third treats price as a statement about value: tied to what the customer gets, and reviewed as costs move.
The bigger point is that price is where marketing and finance meet. It's the one number that connects what customers believe about you to what the business can afford to do for them. Set it carelessly and both sides suffer. Set it deliberately and it becomes one of the decisions with the most effect on your profit.
How Gridwerk helps
Working out your real margins product by product, setting prices that match your positioning, and connecting both to your overheads is part of our Sales & Marketing and Financial Intelligence services. If you suspect your prices haven't kept up with your costs, start with the free diagnostic. It's eighteen questions, about seven minutes, and then we call you to go through the rest.
Gridwerk diagnostic