Most business owners never step back to really consider who their target market is and how many clients or customers they actually need to have a profitable business. The human mind’s instinct is to have “as many as possible” or “have it all”. This can sometimes be called “greed” which our current culture says is good.
However, if you think about it, the primary purpose of a business is to be profitable. It is not to have as many customers as possible or to have every one as the customer. There are always exceptions to this, of course. Google for example wants every one to use their search engine. Apple also wants every one to buy their products but sets a certain threshold by pricing it’s products high?
Having a profitable business is the fundamental mission of any business. At least, it should be!
With out profit, there would be no money to plough back into the business and there would be no innovation and no growth. With out natural organic growth, the business would be precipitously close to the edge and at the mercy of the winds of change.
However, the key to profits is not getting the most number of customers. The key is having a good pricing strategy and a business strategy that supports the pricing strategy.
PRICE WARS LEAD TO DISASTER
Years ago, I used to run a graphic design business aimed at the lower end of the market. It started in 1998 with a noble intention to help small business get affordable and yet high quality logo and graphic design services. The first few years were great and we were doing what we set out to do. We worked with both local and national small businesses and helped them create identities that were on par with the big players.
Once the online revolution began circa 2003, our market segment was hit with a wave of similar online logo and graphic design companies – most based overseas. Initially, along with the other pioneer US based online graphic companies, we welcomed the competition. But thinks quickly went from bad to worse as most of these overseas “design companies” were slashing their prices left and right. Like the other pioneering firms in the US, we started to respond to these changes by cutting our prices to remain competitive. We were dominating Google search and hence we felt that the volume of sales and projects will make every thing alright.
This got so bad that there were companies offering unlimited design concepts and unlimited revisions for as little as $25! For a designer sitting in Indonesia or Pakistan, $25 may be a good amount and a handful of such projects would mean a decent income. Seeing this work, more and more firms started cropping up. In fact, some of the major overseas players started creating fictitious companies and websites just to get more exposure on Google.
While the volume increased, the project fees feel and pretty soon, with out even realizing it, we were operating the business at a loss. For a $250 project, we were spending over $400 worth of time and effort! By circa 2010, this company almost went bankrupt! To cut the long story short, I did manage to extricate the business out of that hell hole of a market segment and turned it around. I understood the relationship between pricing and profits and applied the principles I had learned to create a profitable business.
PRICE BY VALUE
If you are in a market that is dominated by price wars and your target market has been habituated to expect the lowest price offering, then trying to compete by reducing your prices would be a killer mistake. You want sales and it is obvious that higher prices would mean lower sales and eventual extinction. I am not advocating that you simply raise your prices and expect to remain in business.
For years, I used to get my hair cut for $20 at a local barber. The results were always mixed, ranging from “oh, well” to “oh! my god!”. One day, I walked into a stylist at the local mall, completely on a whim. I gaped at the price tag of $90 for a hair cut! I was feeling good and decided to go for it. That was the best experience I had in terms of getting my hair cut. And guess what, I have been going to the expensive stylist ever since.
The stylist went beyond just giving me a hair cut. When you walk in, the ambiance of the place was superb. The theme and decor reminded you of the vintage years. There was an old fashion radio playing songs by the likes of Sinatra. As you waited in the lounge, you were given some sweet Turkish tea (the owner was Turkish American). There was even a smoking room with free stooges! I got some tips from the stylist about my hair and how to keep it healthy.
Although I had an initial sticker shock, I loved the service so much that I have become a regular and in fact pay $110 now. The cut lasts me longer and makes me look good – or at least I believe that it does.
This stylist, rather than trying to offer a cheaper service to attract customers, decided to create a service that had nothing in common with the competition. He effectively removed the competition from the equation and in the process became profitable because of the higher prices.
WHAT IS YOUR PRICING STRATEGY?
How did you arrive at the prices that you charge for your service or product? Did you just arbitrarily select a price point? Is it based on what your competition is charging? Or is it related to the value you place on your services and the strategy you have in place to tell your brand story?
Typically there are 3 general pricing models that most businesses follow:
You calculate the total cost of your service/product (raw materials, production costs, time costs etc) and then add a percentage mark up based on the predicted volume of sales of let us say 2,500 units. For example, let us say your product costs $50 to produce and based on the anticipated sales volume, you decide to add a 20% margin. This results in your product’s price point at $60 ($50 + 20%).
As long as your predicted sales volume target is reached, you will always be in profit and a 20% profit is a very healthy profit indeed. BUT the big question is: “would you always hit your anticipated sales volume”? Sales are largely dependent on external factors of the market place and can fluctuate wildly.
If sales volume goes down, you end up with a loss. So how do you offset this? You should factor in a drop in sales and then increase the price to compensate for the drop. In this example, if your sales volume dropped to say, only 1,500, then you need to increase the margin to get the same level of profits.
In this model, your aim is to get your investment back in a certain time frame. For example, let us suppose you invested $25,000 in your company and would like to get the ROI back in the first year and your expected sales volume is 2,500 units per year. You then need to make $25,000 in profit which means a profit of $10 per unit. This again sets your product price at $60.
Same question: “would you always hit your anticipated sales volume”? Again, to combat any drop is sales compared to what you anticipated, you would have to increase your margins to get your ROI.
VALUE BASED PRICING
In this model, you charge based on the value that your customers get from your product or service. Let us say in the same example above, your widget actually saves your customers time or money or both. If you can effectively communicate this value to your target market, you can then charge more because your customers will be prepared to pay more for the value they are getting.
Let us say, your widget would save you customers over $1,000 a year. Would your customers not be willing to pay $80 for the same product. Perhaps $80 may appear to be too cheap. What about $150 or even $300?
This model is the most profitable one if done right. It all boils down to communicating your value proposition to your audience in a compelling way. Your brand story and message would have to be crafted with diligence to create the right impact.
Of course, with this model, the bottom line is that you would have to charge what would be considered “fair” by your customers. If you product cost $50 to make, then even if it would save the customer $10,000 during its lifetime, they would not be prepared to pay $2,000 or $3,000 for it!
Going forward, I do hope you would keep pricing strategy at the top of your priority list. Think about your model. Conduct an audit to see how you have priced your products or services. Think about how you can increase the profit with out increasing the sales volume. If you can do that, then any increase in sales volume would be a boon.
Finally, do not forget to plough back some of the profits into improving the business. Hedge your business against any potential down turns or future pitfalls. In other words, save for a rainy day. Remember: with out innovation in a business, it is always vulnerable to failure at the slightest challenges!