Pricing strategies vary considerably, depending on market conditions, your product or service offering and the prevailing economic conditions.
Getting the lowest price isn't important to everyone!
1. 10-15% of the population buy the cheapest goods on offer.
2. 80% buy value.
3. 5% buy expensive because they can afford 'the best' and, to them, a high price represents high value.
So unless you operate in a 'perfect market', where the laws of supply and demand affect the price of a commodity, there is always room to appeal to those customers who value what you are selling, and value it enough to pay a little more for it because you are differentiated from the competition.
This is where you need to understand a little bit more about marketing and how to positioning of your business in the market is so important.
This is where your pricing strategies are most important!
There is one golden rule to establishing the right price for anything and that is that the customer will only ever pay what they think it is worth for them.
You must very carefully consider you pricing structure (particularly in a start up business), because whatever the price that you come up with, you are normally stuck with this for a least 12 months.
Therefore, if you get this wrong or you just do what everyone else does, your profits may well be just 'walking out back the door' for some of your products even before you start. That is to say you have not taken into consideration your overhead requirement and/or your point of difference or competitive advantage that can achieve for you a much higher (perceived value) pricing structure.
Flexing or Changing Prices
Small businesses are so often cautious about flexing prices, for apparently good reasons:
1. We are intimidated by the big extremes between the pleasures of high prices and the pain of low prices.
2. We fear that we may lose more customers than we can afford.
3. We don't really understand what motivates our customers.
4. We have calculated price according to what things cost, or what the market go rates are, rather than what they are worth (perceived value pricing).
5. We don't understand how to do 'the numbers' or how we can make them work in our favour.
Let's take a look at what happens to sales and profits when we vary our prices .....
The Effect of Price Changes on Profit
One thing that a lot of business fail to understand is that when you discount your prices you also discount your profit (both gross and net profit). This (unless checked) can spell disaster and usually indicates that the business has not done enough market research and gone into business in a price sensitive market with insufficient product depth. In other words all they have are 'me too' products with no differentiation and all they can do is follow what the market is doing!
Our Widget purchase (cost) price is $30.00
Our Widget sell price is $50.00
Our gross profit on the sale of our Widgets is therefore $20.00.
Sell price less purchase price, this is therefore a 40% gross margin. Not bad so far!
Now we sell currently 5,000 a month.
See the spreadsheet below for a profit & loss snapshot of the business, calculated from the information above.
Pricing Increased to $55.00 per Widget
As you can see a simple $5.00 price increase has increased our net profit by $25,000 dollars, that's HUGE. Remember this when you increase your prices (and your product costs remain the same of course) that price increase drops straight to the bottom line! You should plan to increase your prices at least annually, your prices to operate are going up (fuel costs, labor costs etc) customers will expect you to increase your prices!
Pricing Decreased to $45.00 per Widget
Here the reverse has happened with a $5.00 price discount everything has gone south! Our cost of goods sold % to sales is up to 67% which reduces gross profit. This $5.00 price discount has wiped $25,000 off our net profit (bottom line). So now what happens? If the competitors decrease their prices further what do we do? Follow suit? Only the strong can survive here, the one with the most profit or assets than can be quickly turned into cash! See also Price Elasticity of Demand
The message here is to make sure you are diversified have many products in many market segments, have plans always in place to produce more products and/or services to add to your offering. Do not put all your eggs in one basket, look to get into other areas of different markets, also have you considered exporting your products?
Remember There are 4 Ways to Enter a Market
1. Existing product into an existing market (market penetration)
2. Existing product into a new market (market development)
3. New product into an existing market (product development)
4. New product into a new market (diversification)
Where do you sit right now with the above options for your current and future product/service offerings?
Manage your Sales with Run Rates!
Run rates are a great way to understand whether your sales and margins are on track with budget and to indicate the variances by week, month or whatever period you choose. Also this is a great tool to keep on top of these critical areas of your business, providing a snapshot view this method is a quick and easy method of analysing your business.
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