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Pricing for profit
Deciding what price to charge for your products or services is perhaps the most important business decision that you will be faced with. In this booklet, we will divulge the best ways for you to ensure that the price you come up with is in the best interest of your business.
Different approaches
Have you heard the joke that illustrates the different approaches taken by different groups?
The economist asks "how does it work?", the accountant asks "what will it cost?" and the marketing manager asks "do you want fries with that?".
An understanding of the different approaches to pricing is important. Economics is based upon the theory of supply and demand which leads to equilibrium pricing, where prices are set so that supply and demand equate. If demand exceeds supply then price is increased so that more people want to supply the product or service and less people want to buy it. The reverse is also true.
An accountant will price based upon the notion that if a business is to survive it must sell its products/services at what it costs the business to supply them plus something extra for profit (cost-plus pricing). Although this is probably the most common pricing mechanism of all, it has a serious drawback in that it totally ignores market dynamics, in other words, what customers are willing to pay, what competitors are charging and so on. It is common, therefore, for the cost-plus price to be "adjusted" to take into account external factors.
The marketing approach to pricing is based upon the idea that there is a price for every product/service that the market will bear. There are different pricing systems resulting from this:
- Comparative pricing where prices are set around or below what competitors are charging. There is a danger, however, that a profitable price for one company would be a disastrous price for another with a different cost structure.
- Customary pricing where the market has established a certain set of prices.
- Differential pricing is based upon the technique of market segmentation whereby different types of customers are approached and sold to in different ways and a different price can therefore be charged for what is effectively the same product or service.
- Value pricing takes into account how much the product is actually worth to the customer in terms of saving or gaining money. This may bear no relation to the cost of the product/service.
- Psychological pricing where a price is designed to have a particular psychological impact (or not) on customers. No matter how often we tell ourselves not to be duped by a product price of £9.99, we all fall into the psychological trap of thinking that the product is "less than ten pounds" which is why it remains a popular pricing technique.
- Convenience pricing sets prices for the convenience of the customer. For example, pricing in round numbers for newspapers is common or single coin vending machines.
All of the above must be considered before arriving at a price that will suit your business.
Don’t be afraid to raise your price
Price is only one of the factors that customers take into account when buying from your business. Other may include the quality of the work performed or the product sold, the standard of service received from your organisation and so on. Therefore, raising prices won’t necessarily drive your customers away providing that it is handled in the right way.
For example, you may decide to lower prices of some items in your range at the same time as raising others and so soften the blow. Of course, you can then dwell on the price reductions when communicating to your customers. Alternatively, you can associate a price increase with an enhancement to the product or service that you are offering. In any case, be prepared to justify your prices by demonstrating that your price is still lower than your most expensive competition or by demonstrating the benefits of your offering to your customers.
You may lose some customers, but if the profits of the business go up anyway then it may be a price worth paying. For example, say that you sell 1,000 units of a product each year at a contribution of 15%. If you increase your price by 10% then you can afford for volume to fall by up to 40% before you are any worse off.
Beware discounts
Discounts can be a valuable way to grow your business more quickly than you would otherwise, but they should be used carefully. A common mistake for a sales-led organisation to make is that by reducing prices the volume of business will increase and so profits will rise also. This may be true, but you should be aware by how much volume must increase in order to make the discount worthwhile.
Again, let’s assume that you sell 1,000 units of a product each year at a contribution of 15%. This time, you decide to reduce prices by 10% in order to increase volume. How much more would you have to sell to avoid being worse off? You may answer 400 units or perhaps even 600 units. No. In fact, you would need to double your sales before you are any better off than you were before offering the discount. This demonstrates the need to take extreme caution before offering discounts to customers.
Be flexible
Whilst many customers appreciate some certainty in the price they are charged by your business, that does not mean that you need to charge all your customers the same price. Differential pricing has already been mentioned. This is a useful way in which you can "adjust" your price so that you receive the optimum amount for the product or service you supply. It comes down to what the customer wants from you and what he is willing to pay for.
In reality, you are probably already doing this without even realising it. Do all of your customers receive exactly the same price from you?
You need to divide your customers up into groups with similar characteristics. Then try to establish what these different groups are willing to pay by looking at the prices of competitors, talking to customers to find out what "extras" they are willing to pay for and experimenting with different prices. Before too long you will have a pricing structure that squeezes every last penny of profit from your customer base.
The extras
Unlikely though it may seem, it is possible to introduce price-rises without even raising your prices. For example, why can’t you investigate charging extra for installation, delivery, insurance or handling. Not only is this another way to charge your customers, it has another advantage in that you are actually highlighting the service that you provide your customer rather than disguising it in an all-inclusive price.
Why not look at increasing your minimum order size, and introducing a surcharge for orders placed below this threshold?
When you put your mind to it, there are a number of ways in which you can widen the pricing net.
Interesting
Once considered to be too damaging to customer relations to be worth pursuing, charging interest on overdue accounts is now becoming are more common practice. In fact the right to do so has now been enshrined in law. There is now much more pressure for organisations, especially large companies, to pay their suppliers on time. It has become socially unacceptable to deliberately delay payment. Now, with a new law introduced late in 1998, small businesses will be able to claim interest on late payments at a rate of base plus 8%.
You may need to be careful how you handle and present this to your customers, but the fact remains that if they deliberately withhold payment then you deserve to be compensated for having to wait for your money.
Conclusion
We hope that this brief guide will provoke some thought. It touches on a few of many ways in which your business can succeed. We would love the opportunity to put words into action. Please contact us to find out more.
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