Pricing Strategies for Small Business. Andrew Gregson
5 cents on the bottom line. Better to find a way to increase your prices.
Two studies, one performed by McKinsey & Company and the other by A.T. Kearny, both consulting firms, demonstrated that a one percent improvement in the following areas resulted in net income increasing as shown in Table 2.[1]
Table 2: Pricing Function And The Net Income Effect — McKinsey and A.T. Kearney Studies
Table 2 shows that driving sales volume is not as powerful a path to profit as increasing prices or reducing variable costs.
However, not all hamster cages are created equal. There was a business model in Vancouver, British Columbia, whereby all the products sold at rock bottom prices. The markup from landed cost (invoice cost plus shipping and handling, duty and all other costs attached to get the product onto shelves) covered the overhead and staffing.
The company profit component entered the picture only when staff hit very high sales targets that triggered a sales bonus from the manufacturer. The management had focused their time on negotiating these large bonuses and on driving the large volumes. While from the outside it looked like the business merely spun its wheels, in fact the owners had found a unique path to profit.
You hate your customers
Where price has been the sole focus of the company, it will attract only the most cost-conscious customers. These are the customers who want a discount on every item and ask for a discount even when the product is free. These are the customers who drive you crazy because they want a Cadillac job but only want to pay Pinto prices. These are the customers you hate to see coming through the door.
This type of company attracts only the price-conscious customers who do not really care about the quality of the job or the value the owner places on training employees, longevity in the business, or value-added features. You, as the business owner may care deeply about these features, but these customers place zero value on them.
What would your company be like if there was never any squabbling over prices and every customer beamed at you as they handed over a check? How would your staff react to being treated with respect for a job well done? What would the impact be on your reputation in the community?
Your company has a reputation for high prices
If your company has generated a reputation for high prices but has not successfully communicated the value to the customer, who sees only the sticker price and none of the benefits, you could have a problem. Unfortunately, this customer complains to his or her mother-in-law who mentions you to someone else and the ripple effect begins. Then, too few customers consider buying from your company and the business starves. This is the terror that stalks most businesses.
Summary
Your prices are probably too low if:
• Your company does not generate a profit and a liveable wage for the owner
• You hate your customers because they beat you up on price every day
• You get every job on which you bid
• You just spin on the wheel like a hamster but don’t create profit
Your prices are probably alright if:
• The company has a decent profit
• The owner is paid a reasonable wage
• The company and the owner pay their taxes
• The company has no difficulty finding the cash to pay the bills
• The company attracts the best quality customers who are willing to pay for the value added by the company
• The company’s return on investment is better than that of a bank account
• The bids on jobs are planned to leave no money on the table
• The company loses a pre-determined percentage of jobs to lower bids
In the appendices you will find calculations to help you decide whether, in your business, the problem of low profits is the fault of low prices or some other factor.
The next chapter concerns itself with existing pricing methods, how they work, and their downfalls. After that, the balance of the book is concerned with ways to raise prices by showing real and demonstrable value in what your company offers.
1. Baker, Ronald J. Pricing on Purpose: Creating and Capturing Value. John Wiley and Sons Inc. Hoboken, New Jersey. 2006
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Typical Pricing Methods in Use Today
I will call the following methods of pricing “default” because they appear to be in place in some businesses in the absence of a better method:
• Classical Economics and Ye Olde Supply and Demand Curves
• Follow the crowd
• WAG, SWAG and STICK methods
• Estimating solutions
• DIY (Do It Yourself) Estimating
• The Trap of Customer Driven Pricing
• The Un-Trap of Customer Driven Pricing
Classical Economics and Ye Olde Supply and Demand Curves
“In 1890, the English economist Alfred Marshall suggested that if a parrot were trained to answer ‘supply and demand’ to every question it was asked, the parrot could be given a degree in economics.” [1]
If you studied Economics 101 at some point you probably learned about Alfred Marshall’s supply and demand curves. The intersection of the two lines was meant to indicate where price levels would stabilize in a “perfect” marketplace.
Table 3: Supply and Demand
In Table 3, 50 units will sell at $100. Fewer than 50 units will sell at a price higher than $100 and more units will sell at prices lower than $100.
In Table 4, the point of equilibrium (e) is reached by the intersection of supply at 100 units and at a price of $33.
Large quantities in the presence of low demand means low prices. Supply will increase in the presence of high prices and therefore glut the market, forcing prices down. In reverse, a shortage of inventory in the presence of constant demand forces prices up. The whole system finds equilibrium where the two are balanced.
Table 4: Equilibrium
The supply and demand relationship is used to justify the assumption that dropping prices will result in more sales. However, Alfred Marshall and Economics 101 always prefaced discussion of the graphs “in a perfect world.” Of course, this perfect marketplace bears little