By Ian Ash
Pricing products and services correctly is an essential part of any business – charge too much and you run the risk of not being competitive and not selling enough, charge too little and you may find that you cannot sustain your business since income doesn’t cover your costs. So how much should you charge?
The answer of course very much depends on the nature of your offering and the market in which it sits but perhaps surprisingly I tend to find businesses undercharge rather than charge too much partly due to self-limiting beliefs about what their customers would be prepared to pay and partly because they have not kept pace with prices from their own suppliers.
In fact, in one particular case, we found a business had not changed its pricing on one particular raw material since 1985 and so it was effectively paying its customers to take the component off their hands!
Many businesses take a ‘cost plus’ approach in which all the labour and raw material costs associated with creation and delivery of the product and/or service are calculated and a margin is simply added.
While this ought to provide a level of profit if the costs are calculated correctly, it does not take into account the value of what’s being provided and hence may well be underpricing.
It may also neglect the possibility of possible efficiency improvements within the business so that the cost of production or delivery could be reduced and hence greater margin achieved if the price were left unchanged.
One way to overcome this is to understand the space that your business belongs to and use that to determine possible pricing strategies.
In their book ‘The Discipline of Market Leaders’, Michael Treacy and Fred Wiersema give some insights as to how to think about this.
According to the authors, a business can be associated with only one of three different categories:
1. Product Leadership.
2. Customer Intimacy.
3. Operational Excellence.
Those businesses in the ‘Product Leadership’ sector are seen as market leaders, innovators and provide the highest quality solution.
They typically don’t expect to sell a high volume of goods but those that they do are likely to be expensive and out of the ordinary.
An example would be a high-class restaurant – you go there for a very special meal and experience often for a special occasion and would necessarily expect to pay more for it.
Businesses in the ‘Customer Intimacy’ space focus on establishing long-lasting customer relationships.
Their prices are not very high, but neither are they cheap.
Their revenue comes through being flexible in meeting customer needs and building customer loyalty to create repeat business.
An example here would be a local restaurant; go to their website and you will find “We look forward to serving you” on their home page.
Customers here tend to be regulars but not very frequent visitors.
The businesses that operate within the ‘Operational Excellence’ sector focus on low prices and high volume.
It’s not that they don’t care about the customer experience (far from it – take Bunnings for example where “low prices are just the beginning” yet they still provide good service), but their margins are relatively low relying on high volume sales.
They remain competitive by having very efficient internal systems and processes which are replicated throughout the business.
There are also a lot of restaurant examples here – McDonalds, Subway, Oporto, Hungry Jacks, etc.
So which category does your business belong to?
Ian Ash is the managing director of OrgMent Business Solutions.
