While trying to get a feel for its fiscal health and well-being, one of the first queries I pose to prospective and current clients of my business development consulting firm is “define for me your pricing strategy.” The typical response I get resembles the proverbial deer-in-the-headlights. Oh, they may stutter, stammer and eventually mumble something that sounds like a pricing strategy, but most business owners have not formally developed one—let alone have it written down somewhere. I’ve often wondered why that is so.
There are four widely-practiced approaches to pricing—none of which, by the way— provide the perfect answer to the question “How should we price our goods and services to guarantee we turn a profit?” The four common practices to pricing are:
- Find the competition's price and match or beat it
- Apply a desired gross margin to all products
- Charge all the market can bear, or
- Invent “the better mousetrap” and have customers beat a path to your door
If one subscribes to the notion that the price at which anything is bought or sold—and not product quality, or the company’s service or delivery record—is directly related to the ability of a business to sustain any degree of success, then why shouldn’t it have a thoroughly developed and tested pricing strategy? In addition, that strategy shouldn’t be of the “off-the-rack, one-size-fits-all” variety, either. Does your signage business have a pricing strategy yet? Want one? Let’s get started then, shall we?
What’s your GM?
Of the four common approaches listed above, the most frequently used one is applying a desired gross margin. First, knowing what a gross margin is helps. Gross profit margin is the percentage of the selling price after you subtract what it costs to produce or provide particular goods or services. For example, if something sells for $100 and that item costs $45 to make, the gross margin is 55 percent.
Sounds simple enough, right? Now, remember, that $45 cost includes materials that go into the finished product and/or are consumed during the manufacturing process, production labor, packaging and delivery. Accountants call it “Cost of Goods Sold” (COGS). Businesses in our industry typically enjoy gross margins of between 35 to 70 percent, whereas three out of every four North American companies operate and survive with 25 to 40 percent gross margins.
The “applying a desired gross margin” approach is not without its shortcomings. Just because it costs you $45 to produce something doesn’t necessarily mean customers will buy it for $100. Here is where you should blend in two other strategies—knowing what the market will bear and what your competitors are charging for similar goods.
Just don’t get caught in the trap of saying “If my competitor can sell it at that price, so can I.” You may find yourself saying one thing and really meaning “If my competitor can sell it at that price and go broke, by golly, so can I.” Then it just becomes a matter of who has more money to lose before you both go out of business.
Periodically, you should test the market for all it can bear. Have you ever had a prospective customer come into your shop, ask for a quote on a job, and then leave undecided, only to come back a few weeks later and ask if you would still honor that quote? Actually, you should thank that customer. She has done some valuable market research on your behalf and it didn’t cost you a dime. She’s reporting back to you that, for that combination of quantity, quality, service and delivery, you have the best deal around.
You see, during the two weeks of her indecision, there is a strong possibility that she solicited quotes from your competitors. It is on that particular product and its combination of quality, service, and delivery that you should raise your price immediately after securing her order.
Don’t build a better mouse trap
I agree with Ralph Waldo Emerson, in theory, that if you build a better mousetrap, people will beat a path to your door, but only to the extent that you should constantly be trying to improve your product. Making it better is not the only way to achieve this. Making it faster, becoming the lowest cost producer of it (a.k.a. lowering your COGS), and engineering some other desirable characteristic into the offering are other ways to improve upon it. However, if you hesitate taking a product to market until you’ve perfected the “mousetrap”, you will miss the opportunity to turn a profit today.
Think of it this way. Let’s say you're introducing a new product for the first time and haven't yet completed your unique pricing formula. You will either price it too high, too low or just right—that is, you’ve hit the perfect balance of supply and demand. The latter case is also known as “dumb, blind luck.”
Now, what’s the worse that can happen if you launch the product at a price that is too high? No one buys it, your material suppliers and manufacturing labor will want their money, and you go broke and out of business.
What’s the worse that can happen if you introduce the product at a price that is too low? Everyone recognizes the sweet deal before them and orders for the product overwhelm your ability to produce and deliver it on time. If you miss too many deadlines, the orders will stop coming in — and, eventually you go broke and out of business.
The lesson learned then is “why go broke…tired?” If you're undecided as to how to price your goods and services, err on the high side. You can always reduce the price if you have to, but it’s much more difficult to raise the price on something that was introduced at a steal just to get the ball rolling.
Finding price nirvana
There are many books and websites on the topic of pricing products to sell. Check out Larry Steinmetz’s How to Sell at Prices Higher than Your Competitors—I consider it a classic, must-read business book. He presents a common-sense approach to fetching a profitable, yet fair price for your products and services that outperforms your business rivals.
Also, consider providing training to your sales team on what exactly to do when a prospect says “How much will this cost?” and “Is this your best price?” Those instances are “moments of truth” and what a sales rep says, in response, is critical. Make your sales team the best at appreciating why your price list reads as it does and equip them with the professional know-how to defend that list.
Small Business Development Centers (SBDC) are subsidized by the U.S. Small Business Administration and most are located at many local colleges and universities. They will offer low-cost sales training throughout the year. Give one of them a try. Just remember that the price anything is sold for is directly related to the ability of that salesperson to sell. Usually, salespeople cringe when they hear that, but few argue its validity.
Here are some quick tips to consider incorporating into your own unique pricing strategy:
- If you utilize a mathematical formula to determine selling price based on a desired gross margin, add a fudge factor to account for overhead costs. Collect a small amount on every job to defray the cost of salaried employees, rent, lease payments, utilities and all those other things that aren’t part of COGS but must get paid nonetheless.
- Attract new clients that look, act, sound and smell like your best customers. Describe your best clients geo-demographically and pursue prospective buyers that may be predisposed to do business with you as your best customers do.
- Implement customer loyalty programs—such as frequent buyer rebates, discounts or rewards for referrals, and incentives for ordering early and during your slow periods—so that you can level out the peaks and valleys of your cash flow.
Finally, another way to answer the challenge of “how to determine pricing” is to inspire passion in a professional sales team. Arm them with dramatic sales aids that vividly demonstrate exclusive features and benefits of your products. Support them in setting your products apart from the competition and addressing all your customers’ needs. Just don’t act shocked when your sellers suggest that you should raise prices because they're confident they could sell your product line for more. Good luck.