Pricing Strategies for Small Business. Andrew Gregson
rough and tumble of running an auto-body shop, or roofing a house, or being a consultant. In fact, it bears no resemblance to highly visible and well-documented industries such as those of oil and diamonds. If you consider that a fistful of oil companies and a cartel (OPEC) control the price of gasoline, you will understand that the marketplace is distorted. Diamonds, until recently, were virtually a planet-wide monopoly of the DeBeers company founded in South Africa at the end of the 1800’s. Not only did DeBeers control the mining and distribution, but also the cutting and retailing of the stones. Attempting to compete against DeBeers was like a modern version of Don Quixote charging at windmills on his horse.
Why is the theory so useless to the average small business owner?
Ninety-nine percent of small businesses have no way to test their pricing model daily. If you sold pork bellies on the Chicago Exchange, the price would move each day according to the supply from the pig farmers and the demand from the packing houses. But there is no fluid marketplace for hose reels, clothing, or pasta. That marketplace function is undertaken by the business owner and his or her store. This means that knowing the theory of supply and demand is only good enough for the big picture and that uneven levels of local supply and demand will lead to price differences.
But the supply and demand theory is not dead. The availability of technology is having an impact on informing suppliers and customers, and flattening prices for commodity items. For example, a recent Economist article[2] noted the impact of cell phones on sardine fishermen in South India. Before the advent of cell phones, some 12 percent of the sardine catch was destroyed due to local market gluts. Afterwards, a fisherman with cell phone in hand could find the best price for his catch while at sea and then sail for the port with the highest prices. Prices reached a uniform plateau at 4 percent lower, on average, up and down the coast, and fishermen made 8 percent higher profit.
Table 5: Why Do Prices End In 99¢?
In Canada, knowing that the number of housing starts has fallen will lead you to the inevitable conclusion that demand for lumber, hardware, and fixtures will likely suffer. It will suggest that finding a new market is important or that you need to find a way to out-manouever your competitors.
Knowing that the number of road accidents rises in winter, stabilizes during the shoulder seasons, and rises again in the summer due to vacation travel has an impact on your auto-body and paint shop business, your cash flow, and perhaps on where you set seasonal prices.
Supply and demand also affects businesses for their labor market. In Canada, where the labor market is so fluid, it seems the whole world knows the spread between statutory minimum wage rates and the bottom rung. In a downturn in the economy, the newspaper classified help-wanted ads shrink, and wage rates first flatten and then inevitably go down.
Fluidity also impacts contract bidding. It is a corollary of this type of business that the price is tested on each occasion because someone is asking for bids and your bid has to survive that test each and every time. Bid success is an important “metric” or measurement in business to determine whether prices should move up or down in response to the demand from customers and the supply of competitors.
Where to Begin? Follow the Crowd!
For most small businesses, the opening-day pricing regime starts with checking the competition’s rates and prices, and then following the crowd. This is even the recommended strategy in many popular guides for small business. Merely following the crowd is all right but money is probably left on the table since the business is now just one of many, and the product or service is being priced like an undifferentiated commodity, e.g. pork bellies.
Table 6: Prohibition Story
The upside is that this strategy is simple and easy. You don’t have all the time or money to spend developing a Unique Selling Proposition to get the full value for your services or product and you don’t have to go out of your way to be better than all the rest. (For more about Unique Selling Propositions, see Chapter 4.)
The downside is that if everyone else is not making much money, neither are you.
Example 4
Price matching: Does your company, as a matter of policy, match the prices of your competitors? Have you done this and not revisited these changes in your price list for so long that every item you now sell matches the price of the lowest retailer in town? Are your profits substandard?
For several years a Vancouver hardware supplier went down this road, until the overall performance of the company suffered. Changing price lists on the fly to respond to perhaps fleeting customer demand is easy. Remembering to put the prices back at some point is the hard part. So, margins fell and profits suffered.
WAG, SWAG and STICK Methods
In so many small businesses, pricing goods and services is often based on guesswork, the WAG method (Wild-Ass Guess). WAG is a term to describe an on-the-fly appeal to intuitive processes that lie outside of standard accepted scientific methodology. In other words, it’s a plain, ordinary hunch. SWAG is a not very technical, time-honored acronym for Scientific Wild-Ass Guess, where there are some numbers to back up the guesswork. The STICK method means that every stick and nail is costed out.
WAG is best used only by those who have long experience in the industry or trade. This is an experience-based method for pricing where trial and costly errors have already taken place. If for the past ten years, it has cost $5,000 to renovate a bathroom then presumably it will always cost $5,000 to renovate a bathroom. Faced with creeping labor costs or perhaps sudden spikes in the price of plumbing fixtures, the WAG method, by not examining costs all the time frequently, makes price change sluggish and estimating unreliable. Faced with a new competitor in the market who is willing to undertake the same bathroom renovation for $3,500, the WAG method practitioner does not know how to respond properly. There is simply too much information that must be kept in the estimator’s head to stay current and remain competitive yet profitable. Worse yet, estimators are human and tend to respond to the last comment they had from a customer. If that comment was negative because the customer thought the price was too high, then the price on the next job will drop. If the business owner is also the estimator, then the price might reflect not value to the customer or even costs, but the perilous state of the bank account at the time.
There is a deeper concern that the WAG skill is not easy to transfer because it cannot be written down. In most small businesses where the owner of the company is the estimator, this skill and knowledge is largely not transferable to employees or a new owner. This implies that the business will be undervalued when so much of the company’s way of doing business is buried in the owner’s head. When the time comes for the owner to retire, therefore, the price will reflect that hurdle and the potential for the value of the sale will likely be lower.
SWAG method, as the name implies, has some numbers to back up the experience-based approach. “Okay, so that job will take four laborers five days to complete and I pay them $20 per hour. With labor cost at $3,200, add 1/3 for materials and then 1/3 for profit, that should be about it.” This rough-and-ready method does not take into account travel time, overhead and management costs, payroll taxes, nor fudge factor in case things go wrong. This job might actually lose money.
There is an alternate SWAG method employed in some construction trades — the 1/3, 1/3, 1/3 method. In these estimates, the materials are costed very carefully and the total costs multiplied by three to give 1/3 for the labor (being of equal value to the materials) and leaving 1/3 for profit. As the reader may appreciate, this is a scary method. Paint