One of the themes we often discuss in these articles is the failure of most business owners to think appropriately about the selling price of their businesses. Very rarely do we meet a business owner who is aligned with reality when it comes to what their business will fetch in the marketplace. But that might be part of a larger problem: pricing in general. In this article we’ll revisit what you should keep in mind as you price (or reprice) your products and services.
Many businesses use cost-based pricing. They take the cost they pay for something and add a fixed number or percentage of the cost on top and voila, you’ve got the price. There’s a lot to like about this:
- It’s simple – no complicated formulas
- It ensures profitability – you know that you aren’t losing money on any product
- It helps with bidding on projects – when asked to put forward a proposal one part of your calculations will be straightforward
There are companies that base their pricing not so much on their costs, but on what the customer is willing to pay. An Hermes bag or an Aston Martin car are the most obvious examples, but it’s not just luxury firms that use value-based pricing. There are two keys in value pricing:
- A product or a service that is clearly differentiated from the competition – there must be at least one aspect that is difficult for competitors to emulate well
- A focus on customers that allows improvements or features to be added based on their desires – this implies open communication and strong relationships with customers
A Hybrid Approach
McDonalds is one of the most successful businesses in the world, not just in its corporate profits but at the individual franchise level. They use a combination of cost-based and value-based pricing. For example, the margins on burgers are fairly low or sometimes, during promotions, non-existent, as the burgers may be loss leaders. Where the margins are unbelievable are in beverages, specifically coffee and sodas, and in their famous fries.
As the single largest buyer of potatoes in the United States, McDonalds can almost, in a way, engineer the final price of their fries. Sitting together in an Extra Value meal you have products with wildly different margins. McDonalds has used research to extract the maximum price out of each item, but you can see the philosophies of cost-based and value-based pricing operating in the background. Many places offer burgers, so McDonalds has to offer those burgers at competitive prices, but they have poured so much marketing into their fries that McDonalds fries command a premium: people are willing to pay more for McDonalds fries than for another brand, even if they know that ultimately we’re just talking about fried potato sticks.
Are You Charging Enough?
If you have a business which uses cost-based pricing, are you looking in your blind spots? Are you examining opportunities to curb costs not just with individual products but with the system in general? Are you monitoring the marketplace and in particular, your competition, to see what you’re up against? Complacency kills.
If you have a business which uses value-based pricing, you are dealing with a smaller customer base, hence, are you making sure you are reaching your entire total addressable market (TAM)? Also, are you missing opportunities for cost savings simply because you have been doing things in the same way for a long time? Are you continuing to innovate so that you aren’t just sitting on your laurels, thinking that no one will ever be able to replicate what you do?
We’ve said before that it’s the small tasks that add huge value to businesses, and there’s no need to leave a lot of money on the table for a future buyer to scoop up just because you weren’t willing to do the work to make sure you were charging enough for the hard work of you and your team.
Remember, pricing isn’t a decision you make once and leave alone. It’s one of the key drivers of value in your business, and needs to be tended consistently.
Do you think you might be leaving money on the table by not charging enough for your products and services? Would you like a second set of eyes to help you look at the numbers? Give us a call. We’d love to help!