Author: Michael Prasad August 3rd, 2011 at 6:56 am
All businesses have to deal with setting prices. Yet very few take the time to really use price setting as part of their overall business strategy and improve profitability.
I know that many businesses use a basic set process of cost plus a markup. This process within the business would generally have been established some years ago and has lived on without review or change despite business conditions changing in recent times. When this pricing model doesn’t create the expect level of sales, the immediate response is discounting, leading to further detriment to profits.
What amazes me even more is that many SME businesses use their competitors’ prices as the basis for their prices. This is done without any reference to their own business. I can understand the need for businesses to be price competitive and following your competitor’s prices could be a business strategy, but it is fraught with danger and needs to be handled very carefully if the business is to succeed. The failure to understand the impact of pricing decisions on business strategy and business profits is a common problem and one that little attention is paid to.
Quite often I see business owners fear increasing prices because of losing customers to competitors. Yet in many cases these businesses have very low profitability, and in some cases they have severe losses resulting from these very poor pricing decisions. There is a great need to understand the impact of pricing decisions on business profitability and in particular the difference between “gross profit contribution” and “cash flow”.
Unless the business has a strategy of being a low cost provider, it will not survive by competing on prices alone. There are great examples of businesses having a clear strategy to be a price leader and we can easily identify them in sectors such as travel, supermarket and hardware. We can learn a lot from really understanding how these businesses can compete on price and still remain profitable.
In my view, if your business is not a low cost provider, it cannot compete on price alone and make decent profits. An even greater problem that I have encountered is that many businesses have no understanding of what their customers’ value from their business. Price maybe a consideration in their purchase decision but other factors may have a greater importance to the customer. What a business owner thinks and values is very different from what a customer wants and values from that same business. A greater understanding of your customers and what they value from your business could help you develop a business strategy that provides you with the improved profitability.
Over the coming weeks, I will help you better understand some of these issues around pricing that could improve your business profits and develop a better business strategy for you.
But for now, it’s over to you!
What methods do you use for pricing your business? Do you keep an eye on the prices of your competitors?
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Specialist Chartered Accountant
Michael Prasad (@michaelvprasad) is a specialist Chartered Accountant in the retail sector. He has a MBA with a specialisation in retail and service businesses and over 20 years experience as a Chartered Accountant. He has a real passion for...
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Author
Julian Smith
August 3, 2011 at 10:37 am
Hi Michael – thanks for a great first post and welcome to The Pulse! I think you’re really onto something when you write about the pitfalls and challenges when setting pricing and the business community agrees with you! In the April 2011 MYOB Business Monitor report, “pricing and profitability analysis” was one of the top 3 pressures Kiwi businesses owners worry about. Just after “cash flow” and “fuel pricing”. Looking forward to the next instalment in your advice series!
(You can access the report here | http://myob.co.nz/myob/industry-research-1257828257724)
Author
Michael Prasad Specialist Chartered Accountant
August 3, 2011 at 12:20 pm
Thank you Julian!
Happy to be able to make a contribution and very excited to be working with MYOB.
Author
Emma Mulquiney Online Editor - MYOB
August 3, 2011 at 12:40 pm
I agree with Julian, you’ve really highlighted a very real business issue – one that many business owners can easily fall into the trap of!
I always end up wondering this very thing every time I’m in my local pizza shop. In a suburb full of Dominos and Pizza Huts, this little local joint feels compelled to keep their prices really low to compete – even though their wood fired pizzas are of a far higher quality than the chains. I’d be prepared to pay more – they’re really great pizzas – and they wouldn’t lose my custom if they bumped their prices up a few dollars. I can’t help but wonder how much profit they actually make…
Thanks for your great insights – I’m looking forward to hearing more from you!
Author
Michael Prasad
August 4, 2011 at 2:31 pm
Hi Emma
Yes, businesses can compete on price – but they need to have a clear strategy around this. Otherwise, they risk failure from the pressure to compete with businesses that may have low cost structures and very different objectives. Once a business understands its strategy around prices, it is easy to get the profitability back in. I hope my contribution can help business owners learn a bit more to overcome this common problem and help them develop better strategies to improve their profitabilty and business performance .
Author
John Tsoulos
August 3, 2011 at 5:47 pm
Hi Michael,
All good stuff and agreed people in business get carried away and do not value what they have to sell. Sometimes even people calculate their margins and their mark ups incorrectly. Bute getting back to your post.
There are only 2 strategic positions a business can follow. One is the low cost provider and that can have a broad or narrow focus. Here a business focusses on price leadership. The other option is off-course the differentiation strategy (once again there can be a broad or narrow focus there as well) and the focus here is on being different and charging a higher price.
As per the Disney Way Fieldbook the 2 choices are put this way -
“Offer a commodity product, compete on price alone, and pray that a profitable cost structure can be maintained: or Create a unique experience that far surpasses customers basic requirements, and this fulfills their dreams”.
Most people lose focus on what they are actually offering their clients, customers or patients.
I truly believe this and have assisted in changing thousands of people’s mindsets at my 3 day Global Business Camp events which MYOB have supported in the past. The truth is we do not offer a product or a service.
What we do offer is an outcome, a result, a solution, a benefit or a lifestyle. People come to us so they can achieve their goals and objectives not to buy our product or service. The quicker more people think of their business in that way the better businesses in Australasia will be.
Pushing that barrow further people buy value and there is an equation that relates it like this – Value = Benfits/Costs. Clearly there are only two ways to increase the value. We can decrease the costs or increase the benefits.
It is up to all of us to really increase the value people receive from us. Over the 3 days at our event we seriously focus on helping people increase the value in their business. People end up understanding that only 15% of customers leave due to price, product or service and time. On the other hand 68% of customers that leave do so because of perceived indifference. Perceived indifference is where a customer feels we do not care about them. We may actually care very much but we have not shown it.
So as you can see if we increase the value and focus on awesome service we can increase our prices and customers will be more than happy to deal with us.
Keep up the great work.
Cheers,
John Tsoulos
Author
Michael Prasad
August 4, 2011 at 2:32 pm
Hi John
I see that you are passionate as I am on this issue. Good to see that are like minded people around to help. It would be useful to touch base off line and share some ideas.
With best regards
Michael
Author
sunil kumar
August 3, 2011 at 7:23 pm
Hi Michael,
Your comments are very valuable in todays business environment. My own thinking on pricing is that you should never rip anyone off. I try to use a middle ground type strategy however as a franchise our pricing can be based on benchmarking data. Most of our promotions are directly negotiated with suppliers and is mainly done at head office. Sometimes a low GP on a product is done to attract customers in-store who may browse at other products. A business in an influential area/mall is most likely to have a different pricing strategy as compared to one in a lower socio-economic area. At the end of the day its all about achieving a good stock turn ratio and GP. Every business is different and getting professional advice may be the best solution.
Author
Michael Prasad
August 4, 2011 at 2:45 pm
Hi Sunil
Yes, a business should never set its prices to rip people off. This will be an easy way to failure as customers will not return. Where you have a set environment like a franchise and you have little control over prices, then the strategy must be to devilver exceptional value/service to customers or have a point of difference. John makes good comments above.
As an example, I purchase netball shoes for my daughter each year. The sports shop that I go o spends the extra time to have her fitted in correctly and I am happy with the recommendations and the purchase. The strategy this business uses takes my attention away from price and gets me focused on getting the right pair of sports shoes.
Regards
Michael
Author
Thomas
August 19, 2011 at 12:47 am
Michael,
I am a new business entrepreneur and making my pricing decisions has been based on a mix of factors.
A) Investigate Competitors prices (Market Price)
B) My profit requirements (Cost Price)
C) What I would pay for my product as a customer and then reduced it a little bit to get extra market penetration. (Price points – attractiveness to market)
D) Asked my wife if she would buy my product if she would be present with my offer (Target Market Research / Picky buyer)
Far too often, businesses I see charge a bit too much, to the point a lot of stock is left on the shelf. I think a large portion of businesses are struggling to meet their fixed overheads and feel that way to get a head is to increase prices. Forgetting the turnover part of their profitability equation.
I would suggest that pricing should be based on likely turnover, and the owner has to work like hell to bring in customers. If the turnover doesn’t get to the anticipated level an adjustment in price may be needed to reach desired profit level. It will / may take time to get to that point so you will need a buffer to get you over the lean times.
Whoever came up with the phrase “you can always lower the price, but not put them up” was probably a Def Leppard fan (i.e. what ever sounds good is more important the actual meaning).
I have some horror stories from previous work experiences where management (under the spell of acct) was thinking of killing a product line due to the allocation of (staff) cost between two products. By forcing up the cost on one line, the pricing would have to be increased, to the point we were uncompetitive with market alternatives. In fact, in this case the staff cost are sunk cost so no cost benefits would have been realised if the second product line would have been removed.
My business
50% of my business is referral business, 25% is direct marketing and 25% product placement in retail shops – for me having an attractive price is essential. People have commented, I don’t know how you make any money or that my prices are cheap. My business is a repeat business (monthly cycle). I have the lowest cost base and the lowest price – so I am a price leader. Zero fixed costs and 66%GM. All I need is new customers. This is the hardest point at the moment.
Just read a few books – Never Cold Call Again by Frank J. Rumbauskas Jr. a great read if you want to increase sales without cold calling.
Another book I thought was good the ultimate sales machine by Chet Holmes.
Thomas
BBA (Entrepreneurship and Small Business Management), MBA (International Finance, Investment Management and Global Marketing).