| Economists claim that prices are set by
markets. But they are wrong.
Prices are set by people running businesses. People
like you. And they are among the most important decisions you will ever make.
Get them right and you could be on the road to fame and fortune. But get them
wrong and your business will be doomed to failure.
To prove that setting your prices is one of the
most important things you will ever do, let's start by looking at an example.
Last month Widget Co made £500 profit selling
1,000 Widgets.
Last Month's Profit and Loss Account:
| |
£
|
|
Sales (1000 Widgets at £10 each)
|
10,000
|
| Deduct: cost of sales (1000 Widget
at £7 each) |
(7,000)
|
| |
_____
|
| Gross profit |
3,000
|
| Deduct: fixed overheads |
(2,500)
|
| |
_____
|
| |
£500
|
| |
=====
|
Widget Co has commissioned some market research
which suggests that they have two options:
Option A - They could increase their sales volume
by 20 per cent if they reduced prices by 10 per cent to £9, or
Option B - They could put up their prices by 10
per cent to £11, but then would lose 20 per cent of their sales volume.
When we ask them what Widget Co should do, most
entrepreneurs have no hesitation in saying something like: "Go for option
A. It is always worth selling more, and anyway, WidgetCo gains more in volume
than it loses in price, so it must be profitable".
Are they right? Unfortunately not. And it's precisely
because so many people get this question wrong that their businesses get into
very real trouble.
So let's continue with our example by seeing what
WidgetCo's profits will be next month under each of the two options.
Next Month's Profit and Loss Account:
| |
Option A
Reduce price
|
|
Option B Increase price
|
| |
£
|
|
£
|
| Sales |
(Option A: 1200 at £9 each) |
10,800
|
|
|
| |
(Option B: 800 at £11 each) |
|
|
8,800
|
| Deduct: cost of sales |
(Option A: 1200 at £7 each) |
(8,400)
|
|
|
| |
(Option B: 800 at £7 each) |
|
|
(5,600)
|
| |
|
_____
|
|
_____
|
| Gross profit |
|
2,400
|
|
3,200
|
|
Deduct: fixed overheads
|
|
(2,500)
|
|
(2,500)
|
| |
|
_____
|
|
_____
|
| (Loss)/profit |
|
£(100)
|
loss |
£700
|
| |
|
=====
|
|
=====
|
As you can see, under option A (ie the price cut)
WidgetCo makes a loss and is heading for disaster. It is actually worse off than
it was before the price cut. And it is much worse off than it would have been
if it had increased its prices.
There is nothing very special or unusual about
this example. It simply illustrates a fundamental point that is all too often
overlooked: stimulating sales by cutting prices may boost your top line turnover,
but it can just as easily devastate your bottom line profits.
Like many other companies, WidgetCo will not only
be able to generate bigger profits by increasing its prices. But by reducing its
sales it will also need less cash to finance debtors and stocks, and by eliminating
customers at the cheaper end of the spectrum, it will probably reduce the amount
of money it loses as bad debts.
As a result, when it increases it prices WidgetCo
becomes a leaner, fitter business, providing a higher rate of return using less
working capital. In contrast, when it cuts prices under Option A it becomes a
lame duck. Choosing the right pricing strategy can be the difference between success
and failure. Is your business an Option A or an Option B company?
There may, of course, be times when you can prove
that lower prices will lead to higher profits. For example, in the case of WidgetCo,
Option A's 10 per cent price cut could have been more profitable than Option B's
10 per cent price rise, but only if it lead to at least an 80 per cent increase
in the number of Widgets sold! Ask yourself, is that likely?
All of this illustrates the general rule very nicely:
if you can prove that the demand for your products is very sensitive to changes
in price, then cutting your prices may increase your profits.
But never, never, never simply accept the naïve
equation much loved by salesmen that:
.
The truth is that convenience, habit, concerns
over quality, and the "better the devil you know than the one you don't know"
syndrome, all make many customers reluctant to switch allegiances for the sake
of a few pence or per cent in price. If you don't believe it, ask yourself a few
questions. How often do you switch your allegiances from a favourite supermarket,
garden centre, pub or restaurant just because a new one has opened up offering
slightly lower prices? How often do you even realise that they do offer lower
prices? How often are you prepared to pay just that little bit more for a product
or service that you know, understand and are happy with?
So if you want simple equations, try these two
instead:
Customers care about prices. But they are certainly
not the only thing they care about - and your business and marketing strategy
should mirror that fact.
In other words, you should never compete on price
alone. Instead you should start by making sure that what you are offering exactly
meets the needs of your customers. And then you should sell it to them on the
basis of "best value" rather than "lowest price".
What is "best value"? As we see it, "value"
is the gap between the benefits a customer perceives he is getting and the price
he perceives he is paying. So offering "best value" means offering a
bigger gap than anyone else.
The three keys to offering best value are to make
sure that:
|
1.
|
Your products and services
are exactly what your customers need and want - ie they offer the best and most
appropriate combination of benefits |
|
2.
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Your customers fully
understand those benefits - ie because unless they understand that what you have
to offer is special, they will assume it is average, and that means that you'll
only be able to charge an average price |
|
3.
|
Your prices are presented
in the best possible light |
Get these three things right and customers will
happily pay you more than ever before.
|
1.
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Customers will part with their money more readily, and pay a higher price, if
they know that they can get their money back if something goes wrong. |
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2.
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Study after study has shown that customers are willing to pay more
if you give them great service. Research also suggests that companies providing
great service grow twice as fast as those with bad service. |
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3.
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Perhaps by breaking it up into little bits and
expressing it in terms of pence per day or pounds per usage. This "trick"
is one of the keys to the success of the National Lottery - ie they have been
able to persuade almost half the country to spend £100 a year by breaking
the annual costs down into seemingly insignificant £1 tickets. |
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4.
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In many industries discounts off list prices are the largest single group of costs
- and yet they are usually given with little or no senior management involvement
or authorisation. Considerable savings can be usually be made by tightening up
discount authorisation procedures. Savings that lead directly to higher net prices
and profits. |
|
5.
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For example, replace flat rate discounts (eg "10% across
the board") with step discounts (eg "5% on the first £1000, 15%
on sales above £1000"). Not only do they look more impressive and encourage
people to buy more, but they often also work out cheaper. |
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6.
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Describing your price as an 'investment' rather than a cost
can often go a long way towards persuading customers to buy. |
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7.
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Repeatedly tell your customers that you may have to put up prices
by, say, 20% - but then only actually increase them by less than 20%. (how far
below 20% you pitch the eventual price rise should depend on your assessment of
the true depth of their "horror" when you make the initial suggestion).
By making the eventual price rise less painful than your customers were expecting,
you can turn a potentially damaging increase into a triumphant success. |
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8.
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Try to reduce the prices of some items in your range at the same time
as increasing the prices of most other items so that you soften the bad news with
some good news, and make a point of dwelling on the latter. |
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9.
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Be prepared to explain why prices have risen, perhaps as a result of cost increases,
and point out that, had it not been for improvements in your own productivity
and efficiency, the increase would have been even higher. Better still, explain
that the price has increased as a result of improvements to the quality of the
product. Emphasise the enhanced features, improved packaging, increased reliability,
enhanced customer support, faster and more convenient delivery and any other factors
which make the product better and therefore worth paying more for. |
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10.
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It is vital to have a strong justification and defence for your
high prices prepared in advance. This is likely to include knowing the prices
of your most expensive competition, demonstrating the savings and benefits from
your product and demonstrating that your product is hugely superior and therefore
slightly more expensive because.…. |
|
11.
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For example, consider charging extra for installation, delivery,
insurance, handling, storage, urgent orders or rapid delivery. You could also
try increasing your minimum order size and introducing a surcharge for any orders
below that threshold, revising your discount structure, slimming down the specification
of your product and stripping out any expensive features that are of only limited
value to the customer, and charging interest on overdue accounts. |
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12.
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If a customer tries to knock you down on price, don't change the
price, change the package. In other words, never simply crumble on price, Always
trade a price reduction for some concession from the customer eg a larger order
or cash up-front. |
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13.
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If all else fails, you can always trade a once off price cut for referrals. We
have developed a brilliantly effective script to help businesses like yours do
exactly that. So ask us and we'll explain how it works.
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