Most small business owners try to increase profits two ways: They either try to sell more or cut costs. But there’s another way that, somewhat oddly, often gets overlooked - Pricing. Think of pricing in terms of the value your business offers to customers. It boils down to a simple question: Do you know what your customers are really willing to pay and why?
Thousands of business owners are boarding the search engine optimization (SEO) bandwagon to boost their share of web traffic. They’re experimenting with daily deals, location marketing, social media marketing and other methods to attract customers. But none of these will translate to bottom line success if you don’t optimize your prices.
Research shows that one of the simplest and most effective ways to increase profits is by optimizing prices. In this realm, coming up with the right pricing is a little more science and a little less guessing. Buyers are generally willing to pay for value. The challenge for any local business is to set a price for the value offered that customers will accept.
Nine out of 10 businesses set prices simply by adding up the costs and tacking on a profit margin. That’s usually the wrong approach. Such a “multiple-of-cost” pricing model doesn’t leave room for a value component.
What you really need is a pricing strategy that can help you find and extract hidden profits lurking in your products and services. Without a sound pricing approach based on the value your business offers, you’ll always be hostage to market changes and competitive pressures.
Here are six pricing do’s and don’ts:
- Don’t base your prices only 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 value on a particular product or service. The profit margin on a separate product or service is irrelevant.
- Don’t avoid price changes just because you fear customer resistance. Things change, including customer perceptions, the competitive landscape and your costs. No, you shouldn’t change prices willy-nilly and there may be reasons to delay a price hike. But the most profitable businesses prepare their customers to periodic price shifts and consider it a component of customer service.
- Do set different prices for different customers. Think in terms of customer segments. Different types of customers will have different perceptions of your product or service value and will be willing to pay a different price. Try customizing features, product packaging, service and delivery options, as well as prices, to particular customer segments. That can help you capture additional value created for those segments.
- Don’t compensate salespeople based on revenue or unit volume. Use a profits benchmark instead. Incentives based on volume can hurt profits because salespeople will push to sell more at the lowest price. It gets worse if they have the authority to offer discounts. Anyone responsible for selling should be maximizing profits, not just sales.
- Do spend more time on your most profitable customers. First off, you need to find out who your most profitable customers are. The 80/20 rule usually applies: expect to see 80 percent of profits from 20 percent of your customers. Once you know the most profitable customers, you can go all out to keep them.