Most small business owners try to increase profits in two ways: sell more or cut costs.
But there’s another that, somewhat oddly, often gets overlooked — pricing. Do you know what your customers are truly willing to pay and why?
Thousands of business owners experiment with daily deals, social media and other methods to attract customers. But none of these will translate to bottom-line success if you don’t optimize your prices.
Consider Value First
Before you start thinking about pricing, you have to understand the value you provide.
Value doesn’t exist solely in your products or services, particularly if they’ve become commodities. (A commodity is a good or service that has become so common it loses differentiation.)
But value is something different. You can add value to a commodity product or service through added knowledge, skill or benefits.
Your training, for instance, can add value to the services you provide, particularly if your expertise far surpasses your competition’s.
Or, value can be found in lower costs if you’ve devised a less-expensive way to deliver the same product or service as everyone else.
If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur.—Red Adair
Sometimes, value is subjective. Many brand name products have a perceived higher value — and cost — due to a brand’s reputation alone. Generic store brands capitalize on this difference to offer greater savings (case in point: Costco’s Kirkland store brand).
And there’s room for everyone.
The customer who consistently prefers brand names is different than the one who consistently prefers generic. (Although who hasn’t fantasized about getting premium-quality goods at discount prices now and then?)
How to Optimize Pricing
Optimizing your prices is one of the simplest and most effective ways to increase profits. Buyers are generally willing to pay for value. The challenge for any business is setting prices customers will accept for their value.
Most small businesses set prices simply by adding up the costs and tacking on a profit margin. That’s usually the wrong approach because a “multiple-of-cost” pricing model doesn’t leave room for added value.
If you win more than 80% of your prospects, your prices are probably too low. An ideal customer close rate is between 75% to 80%.—Forbes
What you desperately need is a pricing strategy that finds profits hidden in your business. Without a sound approach to optimize pricing based on the value your business provides, you’ll always be hostage to market changes and competitive pressures.
Here are six pricing dos and don’ts.
Don’t base your prices solely on costs and “the marketplace.” Include the value your business offers as well. If your price is lower than the perceived value, you’re leaving money on the table.
Conversely, if a cost-based price is higher than the perceived value, sales take longer, discounting creeps in and profits plunge.
Accepting “marketplace” pricing is giving up on your strategy. You become a commodity with no value of your own.
Do have different profit margins on different products and services. Customers’ willingness to pay reflects their perception of the value of a particular product or service. No one said all profit margins have to be consistent.
Don’t avoid price changes just because you fear customer resistance. Things change. Customer perceptions, the competitive landscape and your costs all can fluctuate. (Can you say “supply chain issues?”)
No, you shouldn’t change prices willy-nilly; you don’t want to jerk your customers around. And there may be good reasons to delay price hikes.
But the most profitable businesses prepare their customers for periodic price shifts. If you communicate effectively about raising prices, it can become a positive touchpoint in your customer’s lifecycle.
Do set particular prices for particular customers. Think in terms of customer segments. Various customers will have diverse perceptions of your product or service value and will be willing to pay different prices.
Try aligning features, product packaging, services and delivery options as well as prices, to specific customer segments.
You’ll be able to then capture the additional value you create for those customers when you optimize pricing.
Don’t compensate employees based on revenue or unit volume. Use a profits benchmark instead. Incentives based on volume can hurt profits because people will push to sell more at the lowest price. It gets worse if they’re authorized to offer discounts.
Anyone responsible for selling should be maximizing profits, not the number of sales.
Do spend more time on your most profitable customers. First, find out who your most profitable customers are. The 80/20 rule usually applies: Efficient businesses try to make 80 percent of their profits from 20 percent of their customers.
Once you identify the most profitable customers, you can go all out to keep them.
Optimize Pricing For Value
Think of pricing in terms of the value your business offers customers. Be confident in the value you provide.
Using these dos and don’ts, you can arrive at suitable pricing tiers with a little more science and a little less guessing.