Bob Barker used to point out when the price was right but what happens to your business when the price is wrong? Getting pricing wrong is one of the biggest and costliest mistakes you can make and that applies whether you’re a sole proprietor or a Fortune 500 company.
First, a little pricing math. Let’s say you sell a widget for $100 and your gross profit on said widget is $30. After taking out overhead, you’re down to $10. Then the tax man comes along and takes $4 of that leaving you with a whopping $6 on your $100 sale.
Here’s the critical part – imagine you want to win a new customer over with a teensy weensy little $1 discount. Sure it’s a 1% discount to him but you just blew a 10% hole in your overall profitability (changing pricing doesn’t change your cost of goods or your overhead and, after tax effects, the majority of that price decrease hits your bottom line like a sledge hammer).
Conversely, if you’re in a position where you can increase pricing by $1, you’ve just increased your profits by 10% (and in this economy, that’s huge). Pricing matters. Bigtime.
The mistake we often make is in thinking it’s only a 1% price change. You have to look at it from a profitability standpoint. Knowing how hard it is to keep your pricing intact, here are two thoughts on how to get the pricing right regardless of the business you’re in:
Sell Value, NOT Price
It’s very tempting to use price as a selling point. “We’re cheaper than they are” resonates with customers and prospects but, per the above example, you’re probably doing more harm than good with this approach. Only someone like a Wal*Mart who has a truly differentiated competitive advantage due to their cost structure can pull off a strategy like this.
Instead, you should be selling on value. The price they pay for your product or service is an investment. Speak to them about the return they get on that investment. In my business, we charge for training. What we’re selling though is more efficient people and business processes. If our training helps people reduce meetings, junk analyses, and other such tomfoolery and saves them 12 hours per year per person in productive time, the value we’re creating for our clients is tremendous as compared to the investment they’re making.
Take a moment and articulate the value you’re creating for your customers. Try to quantify it. Show them how your solution makes them more profitable. If you can do that, the conversation isn’t about price – it’s about returns on investment. That conversation enables you to price appropriately and not blow holes in your profitability.
Maintain Pricing Integrity
It’s very tempting to cut prices “just this one time” to win that new customer or keep that important account. The problem with this approach (beyond the financial destruction you’ve wrought as I’ve described above) is you’ve signaled the market you’re willing to take less for your product or service.
What happens when another person at your customer hears you cut prices for a different group? They want the same discounted price, right? Or when they hear their competitor is getting a better deal? They want a discounted price. See where this is going?
Cutting pricing is a slippery slope. Do everything you can to be consistent in your pricing across divisions at a customer and across multiple customers. If you have to make concessions, don’t do so on the price per item – instead consider volume rebates or one-time “good customer” rebates rather than messing with the price per item. When you take that approach, your widget still costs $100 in the market and you’ve held the pricing line.
Pricing makes a huge difference. By focusing on value and doing what you can to maintain your pricing integrity, you’ll likely have much healthier profitability than if you run around competing on price and having a sale every other week.
How are you thinking about pricing? How are you maintaining or increasing your profitability in today’s environment?
Note: As part of our involvement with Forbes.com, we’re now participating in a program where we answer forum questions from small businesses as part of the America’s Most Promising Companies competition and program. Definitely check out the program here – there are some wonderful resources available on the site.
This week’s question was “There’s a lot of confusion about whether we are in a deflationary or an inflationary environment. What sorts of pricing strategies should small business owners consider right now?”