How are you pricing your products and services?
If like many businesses, yours has a loose approach to Pricing Policy and how you price your products / services, then this article will show you how a Pricing Policy works and how it can help you to increase profits.
To sell your products / services at the ‘right’ prices: to help your business achieve its profit objectives, you need a Pricing Policy. A set of rules or a process to follow.
And there’s the clue. It’s a policy that sets out how you will price your products / services to maximise profits for the business.
Let’s assume that you want to have a proper Pricing Policy in place that’s based on business fundamentals that will help the business maximise profits.
When pricing your products / services, there are only three things you can achieve.
- Maximum volume of products, by the number of units sold
- Maximum sales revenue, by value
- Maximum profit contribution
Problem is, that it’s never possible to achieve all three at once with your pricing policy, so compromises need to be made.
Production & Purchasing. Wearing your production hat and assuming you produce your own products, you will want prices to be kept low, to keep volumes up and your machines running as efficiently as possible.
This point also applies if you buy-in your products, where you will want to buy high volumes from your supplier, to purchase at the lowest possible price.
Sales. Now put on your Sales hat. In sales, you want prices to be kept low, to beat competitors to the orders, sell lots of products and services and to maximise sales revenue.
This is often the case when sales targets, commission and bonus schemes are based around achieving sales revenue.
Business Owner. Now for the easy one – put on your business owners hat. As a director and shareholder, you will mostly be interested in profit, partly because it’s through generating profit that you earn much of your personal income and you can build balance sheet value in the business – and partly because profit provides the working capital fuel your business needs to develop and grow.
As you can see, no single selling price for your products / services can satisfy all three interests (volume, revenue or profit contribution).
So, what’s the answer?
How should you aim to ‘balance’ these three conflicting forces in your business and produce a sensible Pricing Policy?
Sitting here at my desk as I write this article, I can’t tell you how to work out your actual pricing policy – whether to price for volume, revenue or profit, because calculating your prices is highly personal to you and your business and it’s also a complex process involving your estimates and forecasts of volumes, selling prices and costs, that only you have access to.
I have come across several boilerplate modelling tools to help create the so-called ideal Pricing Policy, but so far, none have come close to working well and it’s because of what I mentioned earlier: that calculating your Pricing Policy is personal to you and your business.
Profit Contribution ‘Sweet-Spot’
Here’s an example of how a business can establish its profit contribution ‘sweet-spot’ that you might find helpful. It shows what you’ll need to consider when thinking through your Pricing Policy.
Are you going to price your products / services to maximise volume, revenue or profit?
Take a moment to understand this worksheet. I want you to fully understand how your Profit Contribution works and how important it might be to your profitability.
The table below represents one product or service.
My suggestion is where possible, to price for maximum profit. Then adapt your marketing and sales strategies to suit the price point at which you’d like most of your customers to engage with the business.
This is clearly the right suggestion because many small businesses are hungry for profit and will likely remain this way for a few years. Profit is what fuels growth, pays the bills and helps build the all-important cash buffer in the business.
In a few years when you have a stronger and more stable business, you might consider pricing strategies geared more towards growth, perhaps by focussing on volume at a lower profit margin if that would help the business: but until then, I bet that your business will be pleased with all the profit it can get.
If your sales targets and sales commission / bonus plans are currently based on sales revenue achieved, find a way to change them to Gross Profit contribution. This will help the business in so many ways including avoiding giving away unnecessary discounts.
The important point here is not to price your products or services in an ad-hoc way, but to adopt a strategy and have a process for how you price them.
I hope this article will encourage you to carefully think through and produce a sensible Pricing Policy that can help you deliver whatever is most important to your business – volume, revenue or profit: and of course, that works well for your customers out there in the marketplace.