Pricing For Profit. Part 1
“The right price is the highest one that fits your business strategy.” Herman Holtz, Business Consultant & Author (….- 2001)
You should bear your business strategy in mind when setting prices. Knee jerk pricing, used simply to boost sales or cash flow by lowering prices in a slack period, can have disastrous consequences for your business in the long term. You should be wary of training your customers to expect low prices. In practice, it can be very difficult to raise prices again, and a price set too low to be sustainable will result in losses for your business.
What is your strategy?
Does your business adopt a “pile ‘em high and sell ‘em cheap” approach or do you focus more on producing quality goods and services? Obviously, your pricing strategy has to reflect your core business values. You can’t chop and change from being bargain basement to top drawer, as your business must develop a consistent brand, which includes your price. Price is your only chance to capture brand value. If you get pricing strategy wrong then you won’t optimise your profit, and worse, you could end up developing a business that can never make money. The strategy rule applies no matter if you are selling:
- Services – from hairdressing to consulting, or
- Goods – from glassware to computers.
Beware the Magic Formula
Many business people want the comfort of a formula, but there is no easy answer. Pricing is more art than science and more a function of marketing than finance. If you simply apply a margin onto your costs, called “cost plus pricing”, you will not optimise profit. Don’t believe me? In the next two paragraphs, there are two scenarios opposing scenarios contrasted, (high costs versus low costs), and in neither situation will profit be maximised.
Costs are high
Your customers don’t care about your costs. They only care about the value that they get. If your costs are high, you are building your inefficiencies into your price and you may be over-priced compared to your competitors. Imagine for example, that you are paying high rent on your coffee shop and you work out that you need to get €5 for every cup of coffee to be able to pay that rent. Your competitor on the same street, might own his premises and be happy to get €3 for every cup of coffee that he sells and still make profit. Assuming you both have nice clean premises and decent coffee, where do you think the customers are going to go? Your customers don’t care about your costs, so don’t penalise them with a magic pricing formula. Change your strategy instead – and that may even mean changing your entire business model or premises.
Costs are low
How do you imagine that Apple set prices for their latest uber-cool gadget? Do they add a magic % onto manufacturing and fixed costs? When Apple launched the iPod in 2001 at a price of $399, it was almost double the price of competing MP3 players at the time. By 2005, they had shipped almost 21 million iPods, so the high price didn’t detract from sales volume. Their per unit iPod profit was almost the same as their per unit profit for their flagship iMac computer. Consumers will pay a premium for highly desirable or unique items, and a crude one-size-fits-all margin pricing formula means that you will fail to capture the value of your brand. Unique, scarce, high quality, these are all positive brand values that will add to the value of your brand and this can and should be reflected in your prices. Cost plus pricing fails to recognise the needs and desires of your customers and does not maximise your profit.
Next time, in “Pricing for Profit”
Over the next two posts, we will explain the difference between costing and pricing and outline the first steps you need to take in order to price your products or services for profit.