Three Keys to Successful Pricing
Setting the most profitable prices
Welcome to the New Year, hopefully one of prosperity and success. It seems timely to begin 2008 by discussing an area that can significantly contribute to your company’s profitability: successful pricing.
Unless you function as a monopoly-and I know none of us do-pricing your products will always be one of the trickiest, yet most critical parts of your business. So this month, let’s examine three keys to help you build a successful pricing strategy: aligning your internal pricing programs, understanding your business costs, and knowing your market.
Become internally aligned
One of the most important characteristics of a profitable pricing program is one that I refer to as "internal alignment." Internal alignment means that everyone in the company, including top management, sales and marketing personnel, accounting, production employees-all the way down to your delivery drivers-understands your company’s philosophies and goals with regards to pricing your products.
Everyone in your shop needs to be on the same page so that daily decisions are consistent with your corporate pricing strategies. Too often, management has specific pricing goals they wish to meet, but they then neglect to share their goals with anyone else in the company. As a result, sales and marketing, production, management, and accounting may all be going different directions and your pricing strategy becomes misaligned.
Begin the process of alignment by deciding on a pricing strategy. You may wish to be the low-price leader in your market place. Or, on the other hand, you may price your products at a premium and sell on high quality and great service. Most of us will typically find ourselves competing somewhere in-between these two pricing strategies, depending upon the job. Nonetheless, it’s critical that all employees in your company understand what you are trying to accomplish with your pricing. Whatever your decision may be, share it with your troops. Whether it’s your overall pricing approach or a specific job that requires specialized pricing, keeping all your people in the loop with all details of the job-including pricing-will keep everyone on the same page.
Here’s an example: Months ago, I had a couple of our senior production staff approach me with concerns about us re-doing a job for a relatively new and premium client. They felt that the quality was sufficient the first time around and that the new client was perhaps taking advantage of us. I realized that they didn’t understand our pricing relationship with this client or just how important this client was, so I shared with them that this was a premium client that demanded the highest quality possible because of the product’s high visibility. I then showed them how the job’s pricing reflected that higher level of service. Immediately their attitude changed and they became determined to make sure the job was flawlessly produced.
Secure the bottom line
The second key to profitable pricing is understanding the costs of your business. Each job in your shop should be analyzed to determine whether or not the order is a profitable order. This requires knowledge not only about material costs and labor costs, but also overhead charges, related sales and marketing expenses, and any other costs that may be associated with the order. Additionally, you must comprehend the relationship of your company’s fixed costs and overhead costs to each job as it is priced.
Only by understanding the cost structure of your business can you determine whether your price is high enough to generate overall profits to the company’s bottom line. Too many companies base their pricing on what they perceive the market will bear or perhaps they simply match a competitor’s price without regards to the cost of the order or the overall costs of doing business.
I can demonstrate the relationship of pricing to the costs of your business in a discounting example: Let’s assume that you have decided to target an 8% return to your bottom line as a corporate goal and your pricing is structured as such. In an effort to secure a large job, however, you offer your customer a 10% discount off your $20,000 price, thus dropping it down to $18,000. While this strategy may secure the job, you now have to figure out a way to make up the lost $2000, all of which came straight off the bottom line. Let’s further assume in our example that you have four additional jobs you are bidding on that would typically average $5000 in price. In order to make up the income lost in the discount for the previous job, you will have to mark up these four jobs to $5500 each-certainly, this now becomes a tougher sale to make versus the discounted sale to your other customer.
While this is a simplistic example, it illustrates the danger of offering consistent discounting without considering the fact that the costs of your business will remain the same. As a result, your bottom line can quickly erode.
One customer at a time
The final key to effective pricing is knowing your market. Once you understand the costs of your business, you then must determine the highest price that your market will bear on a given job to sustain the most profit possible.
The best way to understand your market is one customer at a time. If you have forged strong relationships with your customers, this may be achieved by simply discussing your pricing structure with them. Most quality customers aren’t really interested in getting your products at the very cheapest price possible; rather, they want a win-win relationship where they receive the right product at the right price-a price that allows your business to make a legitimate return. Just like everyone else, you will have your share of customers focused only on the cheapest price possible, but they should be the exception, not the norm.
You can maintain positive profits by working with your clients as business partners instead of adversaries. Comprehending your customers’ needs in relation to their price points and having open discussions with them will help both of you maintain a profitable partnership. This is the simplest way to understand your market, one customer at a time.
While these three keys to successful pricing are by no means all-inclusive, ensuring that all your employees are on board with your pricing philosophies, fully understanding the costs of your business, and knowing your marketplace will be a great start to building a pricing program that will generate long-term profitability for your company’s future.
Marty McGhie (email@example.com) is VP finance/operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.