Nailing Your Pricing
Why do most startups fail their first year of operation?
Who doesn’t want their business not merely to survive but succeed as well?
Pricing is an important aspect of your business strategy, which directly affects and impacts the success and viability of your businesses. In my consulting and coaching experience or remembering myself when I first set up my first business, I wasn’t sure how to price my services either. And this is often an issue with individuals that are just embarking in the business world. Or are afraid to price high, which is another important aspect we will cover in this course. The psychology of pricing and the repercussions subject to your decision and strategy you adopt.
Pricing is one of the most important aspects of a business, as it directly impacts a company's revenue and profitability. The right pricing strategy can help a business attract and retain customers, increase market share, and maximize profits. However, setting the wrong price can have the opposite effect, leading to lost sales and reduced profits.
There are several different pricing strategies that a business can use, including cost-plus pricing, value-based pricing, and penetration pricing.
- Cost-plus pricing involves setting the price based on the costs of producing the product or service.
- While Value-based pricing sets the price based on the perceived value to the customer.
- Penetration pricing involves setting a low price initially to gain market share, and then gradually increase the price over time.
Pricing also plays a crucial role in a company's overall marketing strategy. It can be used as a tool to differentiate a product or service from competitors, or to target specific segments of the market. Additionally, pricing can be used to communicate the quality or value of a product or service to customers.
Many businesses that end up closing literally run out of cash. They end up becoming bankrupt due to cash flow problems. Meaning they are not making enough money. Or else, their revenue does not cover their expenses and they ran out of cash.
But let’s go back to some basic business principles to ensure we are all on the same page here.
Let’s first understand the meaning of cash flow.
Cash flow is the movement of money into and out of a business and is an important indicator of a company's financial health. Positive cash flow means that a business has more money coming in than going out, while negative cash flow means that more money is going out than coming in.
There are several key reasons why cash flow is important for a business:
- It allows a company to meet its financial obligations: Positive cash flow is necessary to pay bills, make payroll, and meet other financial obligations.
- Positive cash flow allows a business to invest in growth opportunities, such as expanding its product line, hiring new employees, or opening new locations.
- A business with a positive cash flow is generally considered to be more financially stable than one with a negative cash flow.
- A negative cash flow can indicate that a business needs to make changes, such as cutting costs, increasing prices, or finding new revenue streams.
- Cash flow can be used as a measure of a company's liquidity, or its ability to meet short-term obligations.
It’s ok if you are not making the profit that you desire, or bring in the desired revenue, provided that you are covering your expenses.
Which is why having a strategy in place is important to factor any unforeseen events.
I would recommend that you adopt a policy where you put aside some money, and I suggest a minimum of about 4 months expenses, as emergency money, that you do not touch.
You can use this money ONLY during emergency situations. This will help you become more confident, give you your peace of mind and enable you to make the right decisions when things get tough, as opposed to making hasty, and possibly wrong decisions when you are under financial pressure.
So, when in difficult situation’s what do most companies do? They start lowering their prices thinking that they can sell more and recover their losses. What they don’t realize is that this strategy forces them to sell more and does not guarantee that they will survive.
Instead of addressing the problem at its core, they make desperate and hasty decisions in the heat of their desperation.
Let’s see another important metric – PROFIT MARGINS.
Profit margin equals sales minus the cost of sales.
For example:
- SALES – If a company sells 100 units of shoes at €50 per unit, their total sales would be €5,000 (100 units x €50 / unit).
- COST OF SALES: If the cost to produce each unit is €30, then the total cost of sales would be €3,000 (100 units x €30 / unit).
- The PROFIT MARGIN is calculated by subtracting the cost of sales from the sales. In this example, the profit margin would be €2,000 (€5,000 - €3,000).
Now, what is the PROFIT MARGING PERCENTAGE?
This is calculated by dividing gross margin by sales. In this example, the gross margin percentage would be 40% (€2,000 / €5,000).
The profit margin percentage is used to calculate the profitability of a company and it is commonly used by investors and analysts to evaluate a company's performance and compare it to industry averages and competitors.
Note that the example demonstrated is a simple one. However, the calculation of cost of sales and profit margin can be more complicated in a real business scenario depending on the company's operations and accounting methodologies.
When determining your pricing, it is crucial to carefully consider your gross profit. Because if it is too low, you cannot scale up. And this can create several problems for a business such as:
- If the cost of producing or delivering a product or service is too high, it can eat into the profit margin, making it difficult for the business to make a profit.
- It can create pricing issues. Meaning if a business is charging too little for its products or services, it may not be able to generate enough revenue to cover its costs, resulting in a low profit margin.
- In a highly competitive market, businesses may be forced to lower their prices to stay competitive, which can also lead to a low profit margin.
- If a business is selling a commodity product or service, it may be difficult to charge a premium price, which can lead to a low profit margin.
Generally, a low profit margin could be a sign of inefficiency or waste within the company’s operations and processes.
Having a low profit margin can make it difficult for a business to survive in the long term, as it may not have enough money to cover its expenses, pay its employees, or invest in growth.
- How can you hire good people and achieve a differentiating advantage?
- How can you invest in more marketing if you don’t have enough money?
- How can you scale up and grow?
- How can you invest in creating and enhancing the customer experience?
Now tell me…what would you prefer to earn a revenue of 1 million euros a year or €700,000 a year?
Let me know!
WRONG QUESTION!
The better question is WHAT is my profit margin? Now, imagine that:
- Company A is making 1 million with a cost of sales of €800,000 a year making its profit margin at €200,000 a year.
- Whereas Company B which is making €700,000 a year but has cost of sales of €200,000 a year making a profit margin of €500,000 a year.
Which company would you rather own and operate?
And think of the needs of a growing new businesses. Don’t you need to eventually:
- Hire more people.
- Invest more in marketing.
- Your cost of sales will grow.
So, as a result as you start growing your overheads will grow as well.
And chances are your profit margin will start going down even though you are making more money. So, in effect, you are putting more effort, you are growing but making less.
This is the fundamental mistake that most growing companies make. They don’t pay attention to their profit margin. But instead, they put too much emphasis on their revenue. Whereas they should have considered increasing their price as well to invariably grow their profit margin too.
Remember this. While your business is growing, you need to increase your profit margin as well, and possibly raise your price.
Which is why pricing your services or product right is a very important element for the viability of your business.
Pay attention to your profit margin rather than JUST your revenue. Most companies that grow and increase their sales eventually go broke. The CEOs think they are doing well because their sales are increasing, and they hire more people and increase their overheads, but they don’t pay attention to their price and invariably profit margin.
I am not saying that revenue is not important. Everyone wants more revenue, but you want that while increasing your profit margin as well. You must make more profit. So, make sure you look at all key metrics, especially when you are growing.
As Dan Lok says: “business is a game of margins not volume. It is the profit that makes sense not the revenue”.
- Also, pricing is an ongoing process that requires constant attention and adaptation. It involves selecting the appropriate pricing strategy.
- Determining the ideal price point.
- Ensuring proper implementation.
However, even the most well-crafted pricing plans can falter without strong leadership and oversight. Make pricing a regular agenda item in management meetings to ensure that your sales team is on board with defending the value of your products. This may require reworking internal incentives, monitoring and controlling target achievements, and redefining roles and responsibilities. Pricing can be a sensitive topic, and it is crucial to have clear communication and direction from upper management.
Also, try and price your service and or product to also include margins for errors, and to be able to over-deliver. Otherwise, if you end up asking for more money because errors were main along the way, your clients will think that you are always trying to make more money out of them. And this will create an element of mistrust.
In the contrary if you have already priced your offerings as such where you can over-deliver you will end up with an extremely happy customer strengthening the trust and bond between you.
So, try and price your offerings factoring in enough buffers.
In today's competitive market, a well-crafted pricing strategy is vital to staying ahead of the game. It ensures that you are receiving fair compensation for the products and services you offer and guarantees the profits necessary to drive growth and change. While cost-saving measures and optimizing sales efforts are important, it's crucial to invest equal energy, time, and resources into fine-tuning your pricing strategy.
After all, it is one of the most significant factors that determine a business's profitability.
