Is the price right?

NO matter what type of business you're in, you've no doubt considered increasing or decreasing your prices in a bid to whet the appetite of your customers.

But knowing whether to offer cut-price deals or jack up your prices can be the difference between success and failure - and yet huge numbers of Australian businesses are setting price on little more than a hunch.

Pricing strategist Ron Wood, of Sydney's Pricing Insight says making sure the price is right is the number one profit lever for any company - and yet 85% of Australian companies have little or no formal documentation outlining their pricing strategy. He should know. Wood has helped some of Australia's best known companies set their prices, including Arnott's, Corporate Express and Mercedes Benz.

He says that growing numbers of businesses sought impartial third party advice when setting price during the Global Financial Crisis, with the changes to the economy prompting many to question if their prices were right.

Businesses attempting to survey customers on price usually find that almost everyone says the price is too high, which is often the response given and rarely has anything to do with price, he says.

Do your research

Crude cost-setting strategies exist in so many businesses, Wood says. In fact, 75% of companies use 'cost plus mark-up pricing', which results in under-charging and missing margins, or overcharging and miss the sale, he says.

"Less than 20% of Australian companies have dedicated pricing management functions to drive margin improvement programs across their business. And yet if companies implement a considered pricing management plan, it can mean millions of extra dollars in gross margin earnings.

"One or two percentage points of margin requires pinpoint accuracy, but it can deliver $1 million plus to the EBIT line," Wood says.

Businesses also have to deal with customers who are increasingly confident hagglers, he says.

"The ability for customers to negotiate price has never been more intense. This is because the internet has made it so quick and easy to access your competitors' prices and empowered them to then come to your business and ask for a discount."

Julia Bickerstaff, founder of Sydney's The Business Bakery, works with SMEs wanting to make sure their pricing gives them a competitive edge.

A fundamental part of business is making sure your costs are in line with customer expectations, she says.

"You've got to know what your bottom price is, and not enough businesses think about that up front."

This is especially the case with a small business starting out, she says. One of the first mistakes made by start-ups is the decision to start selling goods or services cheap with a plan to increase price incrementally. This can be a fatal error, she says.

"This is the wrong approach. You're far better off setting a fair price up front so you're not turning off people who have heard about you from friends and wonder why they're being asked to pay so much more than their friends had to."

Create pricing tools

Wood says value pricing is key, rather than 'cost plus' pricing.

"This means working out what are the real benefits of the product to the target audience, as well as the costs incurred for the product to perform, and then managing the pricing to reflect what your target audience is willing to pay."

He also advocates the importance of creating pricing tools within a business, which enable a business to calculate quotes, discounts and rebates quickly and accurately.

"Too many businesses take ages to get back to their customers with a quote, which can cost them the work."

Brigette Garland is the founder of Brisbane virtual assistant business Bridgeland Administration Services. The first thing she did when setting up her business was to find out what rates were currently being charged by competing operations. She did this by subscribing to online forums specific to her industry, scouring competitor websites for rates and calling competitors and asking for their rates.

"I asked a lot of questions and also gained a lot of experienced replies in regards to how to actually calculate the rate. If it's too high, people will not want your service. If it's too low, then people may think your service is shoddy."

Garland also factored in the expense of having to deduct tax and superannuation. "I knew what I was being paid when I was employed full-time and wanted to project a figure close to this."
Cheap isn't always cheerful

Bickerstaff says so many start-ups set out to be the cheapest in the market, which can set them up for failure.

"A small business often can't afford to be the cheapest. They don't have that ability because they have the costs associated with being a small business.

"And if you aim to the cheapest in the market, then you've always got to be the cheapest, which most small businesses can't sustain," she says.

"And you've got to remember that there's a huge proportion of the market that will choose a $40 bottle of wine over the cheaper varieties because they believe it will be better quality."

Bickerstaff says a business with a gross margin of 40% and a net profit margin of 8% can see a significant improvement to the bottom line by tweaking prices.

  • A 1% increase in prices will increase net profit by 12.5%.
  • A 1% increase in volume will increase net profit by just 5%.
  • A 1% decrease in variable cost will increase profit by 7.5%.
  • A 1% decrease in fixed costs will increase profit by 4%.

"And that's just increasing pricing by 1%. So why don't businesses do it? Often, it's because business owners are fearful about raising prices. They think that if they put their prices up they will drive customers away, but it's rare that it actually happens."

Bickerstaff also urges businesses to resist the urge to discount, saying the above figures work the other way, too.

"In fact, if the business had revenue of $100,000 generated from selling 2,000 $50 items and decided to discount their price by 10%, they would have to sell more than an additional 22% just to be at the same profit they were at before. And then there's the marketing and logistics cost of sourcing and delivering that additional volume."

Businesses can raise prices by focussing on what makes them different to their competitors then determine how customers value that difference.

"A major mistake is when businesses make their product a little different but customers don't care," Bickerstaff says.

"And check your costing. Businesses woefully under-calculate the cost of their product or service. If you get this right, it will force you to put prices up."

Wood agrees. "Remembering that pricing is your most powerful management lever to drive earnings growth and therefore should be a key agenda item for any company's management team."

This article first appeared on SmartCompany.com.au, Australia’s premier site for business advice, news, forums and blogs.

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