Many businesses both large and small make the mistake of trying to increase profits only by boosting volume or cutting costs. There's another vital component that - oddly - tends to get overlooked: Pricing. But this is pricing on a regular, strategic basis - not the rampant, ad hoc discounting taking place now in the face of recession.
Millions of business owners are boarding the search engine optimization (SEO) bandwagon to boost their share of web traffic, or jumping into social media marketing with hope and a prayer. But those tactics won't translate to bottom line success if you don't also optimize your prices. Think of it as VPO, or Value Price Optimization. It boils down to a simple question: Do you know what your customers are really willing to pay, and why?
"Our research shows that one of the simplest and most effective ways to increase profits is by optimizing your prices first," says Per Sjofors, founder of Atenga Inc., one of the nation's largest price consultancy firms. "Buyers are willing to pay for value," he says. "The challenge is to set a price for the value your business offers that customers will accept."
But 9 out of 10 businesses set prices simply by adding up costs and tacking on a profit margin. That's the wrong approach, says Sjofors. Value rarely has any connection to a multiple-of-cost pricing model.
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 pressure.
Here are six of the worst mistakes small businesses make when pricing products and services:
- Pricing Mistake #1: Setting prices around costs and "the marketplace" rather than value. If a cost-based price is higher than the customer's perceived value, sales take longer, discounting creeps in and profits plunge. Or, if your price is lower than value, you're leaving money on the table. And accepting "marketplace" pricing is like giving up on your own strategy. You become a commodity with no value of your own.
- Pricing Mistake #2: Forcing the same profit margin on different products and services. A customer's willingness to pay reflects their perception of value on a particular product or service. The profit margin on a separate product or service is totally irrelevant.
- Pricing Mistake #3: Putting off price changers for fear of customer resistance. Things change, including customer perceptions, the competitive landscape and, of course, your costs. No, you shouldn't change prices willy-nilly. But the most profitable businesses condition their customers to periodic price shifts and consider it a component of customer service.
- Pricing Mistake #4: Pricing the same to all 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. Atenga suggests that businesses tailor such things as product packaging, delivery options, marketing messages - and pricing to go with it - to particular customer segments. That can help you capture additional value created for these segments.
- Pricing Mistake #5: Paying sales people based on revenue rather than profits. Sales incentives based on volume can hurt profits as sales people push to sell more at the lowest possible price. It gets worse if they have authority to offer discounts. Those responsible for selling should be charged with maximizing profit, not just sales.
- Pricing Mistake #6: Spending too much time on your least 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 your most profitable customers you can go all out to keep them.
Need help assessing where you stand on pricing? Atenga, a strategic price consulting firm, has a super helpful Pricing Education section on its website, with pricing resources, pricing FAQ, strategies, success stories and more.