One of the biggest challenges for any business is pricing. This applies not only to a start-up, but also to well established businesses, especially those in lower margin, highly competitive industries. The common theme with most pricing issues is risk: risk setting prices too high and you may push potential customers away; risk setting prices too low and you cut profits.
This “pricing paradox” drives most owners to default to discounting. However, risk in most cases can be eliminated by getting better information. Generally, the more you know, the less risk you perceive. From that perspective, pricing is all about getting as much information as you can about your market, your customers and your own internal numbers that drive your profit.
As I like to say, there are no secrets in business, there is just information you don’t know yet. When it comes to pricing, here are seven ways to avoid mistakes in your start-up. If you can avoid these, you’ll not only be ahead of your competition, but also you’ll be ahead of most other businesses.
1. Going in too low and undercutting all the time.
For some businesses, this isn’t a mistake, it’s an entire strategy, and it’s not a very good one. Going in too low all the time might be great for your top-line revenue number, but it wreaks havoc on your bottom-line profit number – the one you will need to survive. You need to profit and price accordingly. You might not get business out of all of your price-conscious customers, but that’s OK. Your competition will – and then they will have to figure out how to profit from the “price shoppers” when there is little or no profit to make.
2. Using the same margin for all products.
There’s no rule, law or commandment that says all products need the same margin. In reality, slower moving items need higher profit margins. You can afford a smaller margin based on high sales volume. Even then, you should find ways to add value and increase those margins. Because in the end, even those incremental increases over time will make a big difference to your bottom line.
3. Not understanding the difference between margin and mark-up.
Margin is always based on sales price. Mark-up is always based on cost. I once had a client who didn’t understand the difference, and offered a line of products with a 100% mark-up… then had a 50% off sale. The end result? The store was essentially selling the line at cost. Don’t make the same mistake.
4. Forgetting to take all costs into account.
In order to price correctly – every cost needs to be identified. Even “little” things like credit card processing fees – which typically add 1% to 2% on every transaction – add up over time. Other items, like delivery or shipping costs, can also sneak up on you. View them as diligently as you would your cost of goods sold as having an impact on your bottom line.
5. Finding out what competition charges and doing the same.
Instead of “following” your competition, do a bit more homework and start to discover and uncover the value you truly offer your customers. Then price for value. That way, you are in an excellent position to defend your price against the competition, with a lengthy list of your own “reasons why” your offering is worth its price.
6. Setting sales commissions based on sale prices vs % of profit.
For companies using a commission-based sales force, this is similar in scope to the margin/mark-up distinction. Commission based on the top-line vs commission based on the bottom line directly impacts profitability. Again, profit is the only number that matters. Paying commissions out of revenue streams can mean you are literally giving away your company to your sales people.
7. Discounting instead of adding value.
Discounting takes a toll on profits. At just a 10% discount, a typical firm would need to sell 50% more units to keep the same profit on the bottom-line. Costs also increase in the “discount” game, so companies can literally discount themselves out of business. Instead of cutting cash out of the deal, ask yourself if there is there a way you can add value to your product or service. This “value added” proposition means you can “give away” something that won’t come out of your profits. Done right, it can also add to the experience your customer has of both the transaction and your company. A great experience is key to getting that customer back – which in turn is key to a highly profitable company over time.
Avoiding pricing mistakes and being strong in your pricing proposition go hand-in-hand in building a profitable business. Master the so-called “pricing paradox” and you will master an area of business in which even the most experienced entrepreneurs sometimes struggle. Once you do, you’ll be confident that your products and services have value, and you’ll effectively position yourself against competitors who will be too eager to “give away the store.”
You won’t win every pricing battle, but in the long run, your extra profits will take your company to the top.