In some ways, managing a business is not so difficult, at least from a financial perspective. By attracting more customers or selling more to existing customers, you grow revenue. You also try to ensure that revenue greatly exceeds expenses – in which case profits are high!
Simple, right? But what’s missing from this analysis?
Let’s talk about pricing, something that is often neglected by management. And yet a sensible price strategy can have a significant positive impact.
Consider a business with $1 million in annual sales which raises its prices by 5%. All things remaining equal, it will have $1,050,000 in sales after the price hike. Importantly, that extra $50,000 flows directly to the bottom line because there are no extra costs associated with generating this additional revenue.
We also have to consider how this will impact customer demand. Will customers continue to buy your products if you increase price? Will you attract new customers at the same rate? At some point a price increase will result in REDUCED revenue. Different markets will have different levels of price sensitivity, or what is known as “price elasticity”.
There is no formula for determining price but here are some factors which should influence your decisions (again, depending on your business and industry):
- ‘Positioning’ of your business, for example, as a ‘premium’ seller or a ‘commodity provider’. If your customers perceive you to be high-end, you will be able to charge more. But this perception needs to be earned.
- Value-based pricing. By understanding what your clients REALLY value, you can link your price to that value. For example, if you offer the opportunity to attend an event full of celebrities, you could charge a high price PROVIDED the audience values association with those celebrities.
- Competitor analysis. In all markets, your customers are choosing between you and your competitors. Therefore, you need to think carefully about how your pricing and value proposition will be perceived in the context of the competition.
- Psychological pricing. If your customers perceive they are getting a bargain or some advantage, that can encourage them to buy. This explains why so many products are priced at $9.99 instead of $10.
- Dynamic pricing. In this case you changeprice based on time or seasonal factors. (Airlines and Uber are good examples, where the price for an identical journey can vary considerably!)
- Penetration pricing. Here you aim to attract customers away from competitors through aggressive discounts and promotions.
- Production costs. Over the long term, your sales revenue must exceed production costs in order to generate a gross profit. So you need to have a really good handle on these costs.
- Market demand. Generally your customers will quickly tell you if your products are priced too high. Ideally, you can test different price points and then respond to the market accordingly.
Some of the above factors may present opportunities for your business. Also, keep in mind these Best Practices regarding pricing:
- Forecast based on changes in price you are considering. This educates you on the potential impact and helps to identify the best options while eliminating the wrong options.
- Test your ideas through formal research, where possible. This is what the largest, successful companies do before they modify price. Informal research can also give valuable insights. Asking a few customers or colleagues for their views is a starting point.
- Review price at least on an annual basis. To make the process more efficient, develop policies or guidelines so you are not starting from scratch each time.
- Get some help especially to understand expenses, cash flow, simulations and forecasting.
Remember, pricing strategy can have a big impact without additional expense. That’s why it should be on the management agenda!
This is general information only. Contact us today for an obligation free chat about you and your business. Follow us on Facebook & Instagram