Introduction
Art critic and social commentator John Ruskin once said, “It’s unwise to pay too much, but it’s worse to pay too little. When you pay too much, you lose a little money, that’s all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do.”
Ruskin goes on to say that it’s impossible to pay a little and get a lot. When dealing with the lowest bidder, you’ll need to add money for the extra risk, and then you might as well put up that total sum to buy a higher quality product or service.
As a business owner, you improve profitability in business by either making a larger gross margin on each dollar of sales or by selling more without increasing your fixed costs. It goes without saying that the biggest improvement will occur if you can achieve both simultaneously. Here are some tips for achieving both.
Improve your gross margin
Without doubt, the biggest single barrier preventing small business managers and owners from making an acceptable profit is their refusal to charge a price that will enable them to achieve this. You are not in business to match the price your competitors set; you exist to service your customers well.
Remember, your gross margin is the difference between the price of your product and what it costs you to buy or make it. Therefore, the only way to increase your gross margin is to sell at a higher price or buy at a lower price.
In most instances (but not all) you will have limited scope to buy at a lower price. For this reason your selling price is the critical variable.
Trying to hold or win market share on the basis of price discounting works for very few businesses. It is relevant and applicable in only one situation, and that is where you have a definite cost advantage (either variable or fixed) over your competitors and your product or service is one where customers are very price sensitive.
In fact, studies of the factors people regard as important influences on their decision to deal with a particular business indicate that product and price are relevant in only 15 percent of cases. If you are buying the same brand of laundry detergent, you will pick it up at the store that sells it for the lowest price. However, you choose the detergent because you perceive that it works better than other detergents. You will also pay more for a service if you perceive that it works better than other similar services.
Raising or Lowering Prices, What Works Best?
Discounting doesn’t work as a long-term strategy in business. Consider this: if you lower your price by 10 percent to get more business, and you are currently making a 30 percent profit margin, you would have to increase your volume by 50 percent just to make the same amount of gross profit! On the other hand if you raised your prices by 10 percent, you could afford to lose 25 percent of your sales volume and be no worse off than you were before.
If you’re like those many small business people who regard price as the only factor influencing the buying decision of their customers, you will undoubtedly reject the proposition that a high price strategy (and by implication, high value) will work. You may accept that perhaps it’s right for some businesses, but it sure doesn’t apply to your business. And yet, we’ve seen that almost any business has the potential to command a premium price for its products or services. That is, and this is the crunch, the business is able to market those products or services in such a way that the customer perceives added value.
Think about the insurance industry for a moment. They are a highly commoditized market. Yet, each agency highlights a distinct value for choosing their service – be it “gap coverage” or “quick response” or “accident forgiveness.”
If all of your marketing effort, all of your advertising and all of your sales dialogues focus on price, then you will be beaten on price every time a competitor comes along with a lower one. In other words, if you make price the critical factor, it will be the critical factor.
The only way to get out of the price trap is to promote other features and benefits that you can offer your customers. For example, better quality, longer warranty, satisfaction guarantee, 24-hour
accessibility, more convenient location(s), greater resale value, etc. It might be that your competitors offer all of these things, but unless they also emphasize this in their marketing, how will the customer ever know? Think about this for a moment. Your job when discussing your product or service is to build on what your customers value most, and then back up what you sell with superb service. The thing to remember is that price is only important when all other things are equal.
Some customers only think in terms of price. They are better left to your competitors. What you should be doing is working with those people who are happy to pay for value. This means two things. First, you have to deliver value (embody service) and secondly, you have to educate your customers to be aware that they are receiving value. One without the other will leave you exposed.
Contact LSL CPAs and we’ll send you copies of our pricing tables that will prove the benefits of raising prices vs. discounting to improve your profitability. We can also schedule a complimentary consultation on developing a premium pricing strategy for your business.
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Feel free to contact LSL’s Assurance Manager, Adam Odom, CPA, at [email protected]or call him at (800) 836-8027 to set up an appointment. We look forward to hearing from you!
