Sunday, July 17, 2011

Pricing for Profits

“It is the superfluous things for which men sweat.”
~Seneca the Elder~

One of the most difficult tasks an entrepreneur has is pricing their products. Pricing is one of those things that requires experience and experimentation. Set prices too high, and revenues fall. Set them too low, and though revenues increase, profits plummet.

I was at a large flea market in South Florida one early Sunday morning and was carefully watching the vendors at the various booths. Every so often, a customer would come in, look at a product and make an offer below the listed price. Certain vendors would turn down the offer outright, and the customer would walk away. Some other vendors, however, took a different approach to selling the same type of product. These vendors would answer the low-ball price with a counteroffer, which typically led to a deal.

The first set of vendors clearly thought they were preserving their margin by not negotiating on price, where the other set of vendors was willing to give up some margin in order to make the sale. In both cases, there was very little chance of repeat business.

The lesson here is that if you are selling a homogeneous product with little chance of repeat business, anything you can negotiate above your cost is gravy. Obviously, you want to get as much as you can without losing the customer.
We were helping a neat lady who owns a catering business that has not been doing well financially. When we started talking about pricing, she said she takes her food cost and doubles it to determine the price she will charge for a given event. However, most restaurants want food costs to be under 30 percent of the price charged. This entrepreneur was charging $200 for an event that cost her $100 in food when, according to industry standards, she should have been charging more than $300.

Once I gave her the formula to determine the appropriate price (food cost times 3.2), her revenue fell by about 10 percent, but her profits rose out of the red and she made more money than ever before in a six-month period.

There are three general pricing methods. With the first, you take all of your costs and add an amount for overhead and profits to determine price. I call this the “cost plus” approach. A second method is to evaluate what your competitors are charging and set your price accordingly. A third method is to consider perceived value, which is the value your customers assign to your products and services.

As a general rule, you want your prices to be neither the highest in the market nor the lowest. Just higher than the average price for a similar product is probably a good place to be as consumers typically see a higher price as an indicator of greater value.

Clearly, your objective is to land on a price that is fair for your customers but also capable of earning you the maximum possible profit. Finding this optimal figure takes constant tinkering and continual monitoring.

Now go out and make sure your prices are appropriate and that you are monitoring them constantly to ensure they remain at the optimal level for your business.

You can do this.

No comments:

Post a Comment