The secrets of pricing for profit - Part 1

This first part of a publication on maximising prices and profits is about setting your prices. The whole publication is available free just by sending an email to office@hixsons.co.uk. Include your name and address please, and what you do, so we can see what else we have you might benefit from.

Economists claim that prices are set by markets. But they are wrong.

Prices are set by people running businesses. People like you. And they are among the most important decisions you will ever make. Get them right and you could be on the road to fame and fortune. But get them wrong and your business will be doomed to failure.

Why so many businesses get it wrong

To prove that setting your prices is one of the most important things you will ever do, let’s start by looking at an example.

Example:

Last month WidgetCo made £500 profit selling 1,000 Widgets.

Sales	(1,000 Widgets at £10 each)	10,000
Deduct: cost of sales	(1,000 Widget at £7 each)	(7,000 )
Gross profit		3,000
Deduct: fixed overheads		(2,500 )
Profit		£ 500 profit

WidgetCo has commissioned some market research, which suggests that they have two options:

Option A - They could increase their sales volume by 20 per cent if they reduced prices by 10 per cent to £9, or

Option B - They could put up their prices by 10 per cent to £11, but then would lose 20 per cent of their sales volume.

When we ask them what WidgetCo should do, most entrepreneurs have no hesitation in saying something like: "Go for option A. It is always worth selling more, and anyway, WidgetCo gains more in volume than it loses in price, so it must be profitable".

Are they right? Unfortunately not. And it’s precisely because so many people get this question wrong that their businesses get into very real trouble.

So let’s continue with our example by seeing what WidgetCo’s profits will be next month under each of the two options.

Next Month's Profit and Loss Account – Option A reduce price
		£
Sales	(1,200 Widgets at £9 each)	10,800
Deduct: cost of sales	(1,200 Widget at £7 each)	(8,400)
Gross profit		2,400
Deduct: fixed overheads		(2,500)
Loss		£ (100) loss

Next Month's Profit and Loss Account – Option B increase price
		£
Sales	(800 Widgets at £11 each)	8,800
Deduct: cost of sales	(800 Widget at £7 each)	(5,600)
Gross profit		3,200
Deduct: fixed overheads		(2,500)
Profit		£ 700 profit

As you can see, under option A (i.e. the price cut) WidgetCo makes a loss and is heading for disaster. It is actually worse off than it was before the price cut. And it is much worse off than it would have been if it had increased its prices.

There is nothing very special or unusual about this example. It simply illustrates a fundamental point that is all too often overlooked: stimulating sales by cutting prices may boost your top line turnover, but it can just as easily devastate your bottom line profits.

Like many other companies, WidgetCo will not only be able to generate bigger profits by increasing its prices. But by reducing its sales it will also need less cash to finance debtors and stocks, and by eliminating customers at the cheaper end of the spectrum, it will probably reduce the amount of money it loses as bad debts.

As a result, when it increases it prices WidgetCo becomes a leaner, fitter business, providing a higher rate of return using less working capital. In contrast, when it cuts prices under Option A it becomes a lame duck. Choosing the right pricing strategy can be the difference between success and failure. Is your business an Option A or an Option B company?

There may, of course, be times when you can prove that lower prices will lead to higher profits. For example, in the case of WidgetCo, Option A's 10 per cent price cut could have been more profitable than Option B's 10 per cent price rise, but only if it leads to at least an 80 per cent increase in the number of Widgets sold! Ask yourself, is that likely?

All of this illustrates the general rule very nicely: if you can prove that the demand for your products is very sensitive to changes in price, then cutting your prices may increase your profits.

But never, never, never simply accept the naïve equation much loved by salesmen that:

Lower prices = Higher sales = Higher profits.

The truth is that convenience, habit, concerns over quality, and the "better the devil you know than the one you don't know" syndrome all make many customers reluctant to switch allegiances for the sake of a few pence or per cent in price. If you don’t believe it, ask yourself a few questions. How often do you switch your allegiances from a favourite supermarket, garden centre, pub or restaurant just because a new one has opened up offering slightly lower prices? How often do you even realise that they do offer lower prices? How often are you prepared to pay just that little bit more for a product or service that you know, understand and are happy with?

So if you want simple equations, try these two instead:

Lower prices = Lower profits (until proven otherwise)

Higher prices = Higher profits (until proven otherwise)

Next - Pricing for maximum profit

IS THERE ANY GOOD NEWS?

With the Chancellor’s Autumn Statement predicting more borrowing and less growth, the Eurozone crisis dragging on and talk of a “double dip” recession, one starts to wonder: “where is the good news?!”

Well there IS good news, but YOU have to make it happen!

Our most successful business clients have one trait in common: they understand that they cannot control global economic events, they can only control events local and relevant to them. But how do you remain successful locally?

Firstly, it takes time for global economic events to filter down to local markets. When an event happens there is always a certain amount of time to alter your business strategy. If you haven’t set targets then you can get carried along like a paper cup on the ocean, which can lead to you as a business owner feeling out of control. This is what happens without targets and a strategy for long term survival, so please talk to us about your goals for the future.

Secondly, successful business people understand the need to be flexible with the way they deal with suppliers, employees and customers.  Brainstorm with your team about how you can be more efficient in your daily operations and consider how you can deal with your customer’s needs more effectively. Then set an action plan for change. Our most successful clients do this regularly and are prepared to change their methodologies – in essence, they are flexible in the way they operate. Remember to focus on what you can change and don’t worry about what you can’t! We work with them regularly to ensure they are on top of their strategies and in front of the action, wherever it is.

There is a well-known principle called the “Parato Principle”, which is also known as the 80:20 rule:

Ø  80% of sales come from 20% of customers;

Ø  80% of complaints come from 20% of customers;

Ø  80% of your profits come from 20% of the time you spend;

Ø  80% of your sales come from 20% of your products;

Ø  80% of your sales are made by 20% of your sales staff

Therefore focus on the most effective areas and eliminate, ignore, automate, delegate or re-training the rest.

Set targets, focus on what you can change, ignore the rest and you will create your own good news!

£1000 to help you grow

Grants from the Government are available to help you sort out your strategy, get more profitable, streamline your systems and much more.

You can get up to £1000 quite easily and quickly for short term projects that can really make a difference to your business.

The signs are such that we are now expecting a downturn in the economy in 2012, so it’s wise to get everything working at its optimum level now to protect your business as much as possible.

We have helped clients with:

•          Strategy
•          Growth
•          Profitability
•          Cash flow
•          Systems streamlining

We’ve also used the same techniques to create a succession plan to hand over to the next generation,  changed a company’s manufacturing base and created more sales focus, groomed a business for eventual sale,  and found better ways of paying  the owners so that the company’s cash flow is improved.

This grant will be available potentially until March 2012, but it has to be used by then, so apply soon to ensure your business gets the help it needs.

Give me a call to discuss it on 01202 520010 or email nick@hixsons.co.uk

The 7 P's of marketing services

The 4Ps’s of marketing plus People, Process and Physical Evidence- these all relate to the marketing mix of a service.

People

If you are offering a service, you need the appropriate staff to deliver it. Customers are not just buying a product, they are buying into an experience. Proper recruitment, proper training, and imbuing the staff with a customer service ethos are essential if you want a competitive advantage. Customers make judgements on the service based on the people they interact with. Good products can be assumed to be bad if the customer service is bad. Treat people as you would want to be treated. Walk the customer journey (see Process below as well), to ensure that your customers get the right impression right through the service cycle.

Process

The systems and processes that deliver the service. If you go into MacDonald’s and get your meal in 2 minutes, someone has designed exactly how that has to happen – every time. Someone has thought out what the customers’ experience should be from entering the premises to leaving them – every step, every possible interaction. Work out what enables you to deliver your service effectively every time, so your customer is delighted. Walk the customer journey! Write it down - teach your people, so that they (and new employees) do it the right way every time. That way it gets to develop your brand.

Physical evidence

What is the service being delivered? This element enables the customer to make judgements abut your business. Do you expect a restaurant to have a clean, welcoming, friendly environment? Do you know the old Coffee Stain Survey results? On an airline’s drop down tables, if there was a coffee stain, travellers assumed that if the airline couldn’t clean the tables, they wouldn’t take care of the engines! Make sure that whatever your customers take away reminds them favourably about your service.

And download my e-book Customer Service – Why Bother? Free at www.hixsons.co.uk

Marketing - the last of the 4P's

Here’s the last of the 4 P’s of marketing – PROMOTION

It all means nothing if the benefit of your product hasn’t been clearly communicated to your target market. This might be a mix of:

Public relations

Advertising

Sales promotion – a short term fix to increase sales, maybe with money off coupons

Personal selling

Direct mail

Internet marketing

You will need a well thought out message strategy. What message are you trying to convey and to whom? How will you deliver the message? Will it be through some branding, design or logos? The message should emphasise the benefit of the product and help the business in positioning the product.

Will you use a push or pull strategy perhaps? A push strategy is where the manufacturer concentrates marketing effort on retailers to convince them to stock the product. A pull strategy is where the business instead concentrates on consumers to create demand. Or some of both?

An old favourite – AIDA. It’s a communication model to aid selling. It’s an acronym for Attention, Interest, Desire, Action. When you are new in the market with your product, you first need Attention. Once you’ve done that how can you hold Interest, through stating benefits etc? Then how do you make your product Desirable? A demonstration, perhaps? The lastly, purchase Action – make it easy to purchase.

As your products move through the 4 stages of a product life cycle, you will need to promote them differently to ensure the best success and longest life of each product.

Introduction – new product, so you need to inform the target customers. You may need quite a bit of effort, with Push and Pull strategies at this crucial phase.

Growth – as the product becomes accepted, you need to work on a strategy of increasing brand awareness to encourage loyalty.

Maturity – brings increased competition, so the business needs to persuade customers to buy theirs and not a rival. Display differential advantage to the target audience to inform them of benefits.

Decline – use a strategy of reminding the customers of the product to slow down the inevitable. You may change the price to increase sales.

You will also want to ensure that you have different products at different stages of their product life cycles, to ensure you don’t have a sudden slump in sales, or cannot meet demand if there is a big increase.

There you are- the 4 P’s of marketing, in as short a form as I can manage it. Our strategy sessions focus a lot on marketing and the pricing conundrum. You just have to ask.

Marketing - the 3rd of the 4P's

Here’s the third P of the 4 P’s of marketing. It’s

PLACE

It means how you will distribute the product or service you have, not where you will base yourself. You must get the product to the user at the right place and at the right time – the right place and time for the user, that is. This means effective distribution or you will not meet your marketing objectives. If the business underestimates demand and customers cannot buy from you, then obviously profits will go down, but more importantly, reputation will be lost as customers will know not to try and buy from you again.

There are two types of distribution channel available – indirect and direct. Indirect means distributing your product via a wholesaler who may sell to a retailer then on to a customer. Direct means from you straight to customer. The direct channel gives you complete control over the product, and usually means better margins (you are not giving anything away to wholesalers or retailers), but your ability to sell in volume is limited.

There are three common distribution strategies available.

Intensive distribution – to distribute a low priced or impulse purchase like chocolates

Exclusive distribution – to a single outlet. Usually for high priced products and needs an intermediary to add detail into the selling process.

Selective distribution – a small number of retailers are chosen, and is commonly used to distribute items such as computers or household appliances, where customers shop around and manufacturers want a large geographical spread.

If a business decides on one of the later two strategies, then it should choose intermediaries who are experienced in the industry and have credibility amongst the target customers.