The Importance of Pricing

idea_lightbulbWhen it comes to pricing goods and services in your business, how do you measure what is considered a fair and reasonable price, let alone how you can increase your prices as and when you need to? Too often we have seen clients struggle with this as they fear losing customers. Many business owners give discounts to customers even when they don’t ask for one. Does this sound familiar? You can increase your prices, even at the risk of losing a few customers, and maintain your position.

These days it always seems like the major retailers are having a sale. Pre-Christmas sales, Boxing Day sales, New Year’s sales, Easter sales, new season sales, end of season sales and so it goes on. In fact, when are they not on sale? On the other hand, discounting is a classic mistake that is hurting business owners around the world.

What we have found working with clients who do apply price increases is that they usually do not suffer any material drop off in volume. The following are some examples for you to consider:

  • If you run on a 35% gross profit margin and increased you prices by 10%, you could afford to lose 22% of your average customers before you would be any worse off;
  • At the same gross profit margin of 35% with a price increase of 20%, you could afford to lose an astonishing 36% of your average customers before finding yourself in a worse position;
  • If your business operates at a higher profit margin of say 60%, with a price increase of 10% you could afford to lose 14% of your average customers. If you increased your prices by 20%, you could afford to lose 25% of your average customers;
  • If your margins are not as high and you operate around a 25% gross profit margin, which is what most retailers do, with an increase of 10% you could afford to lose almost 1 in 3 customers. Increase your prices by 20% and you could afford to see a staggering 44% of your average customers never enter your doors again and be in no worse a position.

The reality could be even better than these examples. More customers equates to an increased cost of servicing, more complaints to deal with and potentially larger overheads. Almost invariably you are better off with a smaller number of customers who pay a higher average cost.

So is it as simple as this? Well, not really. To be able to increase your prices you need to keep testing them. Here are a few general rules to think about as you set your prices:

  1. When you have provided a product or service to a customer previously, you have what is known as price parity. Your customers roughly know what they have paid you in the past and so it is difficult, although not impossible, to significantly raise your prices.
  1. It is possible though to raise your prices by say 10% to 20% and most customers would not notice. Even though they have an idea of what they previously paid you, they usually do not know exactly how much they paid.
  1. Where there is price parity, it is important to mystery shop your competitors to see if your prices are in line, above or below theirs. If you find you are below, and many small businesses tend to be, then increase your prices.
  1. Prices that are too low can create doubt in a potential customer’s mind as they will question the quality and value of your product or service.
  1. Consider to what extent you are able to price your service based on the value you create for your customers, rather than on a time and materials basis.
  1. If you want to increase your prices, consider ways in which you can lift customer service to justify the increase. Good customers will pay more for a better experience.
  1. In situations where you create a new product or offer a new service, you have no price parity. The general rule of thumb is to start with higher prices. It is easier to lower your prices if necessary than it is to increase them.

If you would like more information on the importance of pricing in your business, then please contact us. We can guide you to test price increases and help you to measure the impact.