Pricing

Marketing Booklet

by Tom Gray | on Aug 05, 2014 |  Comments

Every business needs to attract more customers, but how? Now there’s a new 60 page PDF booklet with 21 articles covering

  • How to find your competitive edge.
  • Support it with product and pricing tactics.
  • Communicate an attractive offer to the right target market.

What’s the Payoff?

Use this booklet to learn

  • How to use the Competitive Analysis Matrix to find differentiation and create a positioning slogan.
  • Product strategy techniques: design for the experience, augment, bundle, roadmap.
  • Pricing considerations, techniques to think through pricing decisions, and some pricing techniques.
  • How to use the 5Ms to communicate with your target market.
  • How to structure and use a Customer Database.

Order the low-cost PDF download at Purchase Books | BUSINESS TECHNIQUES BOOKS

Get Some Training Too!

For many of us, the written word is not enough. We want to be shown, then practice, and then chat in person about how to do it better. To meet these needs, Tom Gray created Business Techniques Institute – Chicagoland, a group of 12 face-to-face half-day workshops, partnering with local organizations like Small Business Development Centers, SCORE, and local colleges.

Each workshop provides slides and a workbook to apply the techniques to your own business problem during the workshop, and uses one of the booklets as its text.

Small business owners and managers can attend one workshop or several, depending on the topics they want to explore and the problems they seek to solve. The first series begins in September at the College of DuPage Center for Entrepreneurship, 2525 Cabot Drive, Suite 201, Lisle, Illinois. The second series begins two weeks later at the Illinois SBDC at Governors State University, 1 University Parkway, Room C3300, University Park, Illinois.

The Marketing workshop is scheduled for Wednesday, October 1 at COD, and Tuesday October 14 at GSU, 8:30 AM to 12:30 PM. To register, visit Business Techniques Institute | Get Better @ Business

Sample Session: Attend “Pricing Right” on August 20

Get a taste of Tom Gray’s small business techniques and his workshop style by attending “Pricing Right” on August 20 at the College of DuPage Center for Entrepreneurship, 2525 Cabot Drive, Lisle, Illinois. Register by calling the Center at 630-942-2600.

The session covers pricing principles, practical techniques for “thinking through” your price decisions, and some pricing techniques such as differentiated pricing, revenue models, shop rates, and promotions. Workbook practice is not provided in this one-hour session, but one-on-one follow-up sessions are available with Tom or the local Small Business Development Center staff.

Why Not Try It Out?

Want to grow your business? Do you know how? Is there something you could learn about finding a competitive edge, product and pricing tactics, communications choices, and building/using a customer database, or do you know all that already? Why not invest in a booklet and a workshop? For a few dollars and hours, your business could take off to a new level!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

 

 

Ten Pricing Techniques from Business Techniques in Troubled Times

by Tom Gray | on May 02, 2012 |  Comments

Business Techniques in Troubled Times has been running a series of ten articles on pricing techniques. This article sums them up. To see them all, go to Pricing | Thomas H. Gray.

Pricing Basics: Value Positioning and Margin – these are the two basics in pricing. Customers buy value, so you must know what your customers value, and how well you deliver that value compared to competitors. Be better, and charge more. Margin is price minus production and sales costs. You use margin to pay for your fixed costs, and to reach your target profit. So know your costs to set your price, but set it to earn the target profit, not just cover costs.

Margin Analysis Drives Pricing – understand the cost elements for each product, expressed as a percentage of its sales price. Then you can tinker:

  • change how you use a cost element to reduce its percentage of price
  • raise the price itself, perhaps in small bites, or only for products facing less competition
  • bundle low margin and high margin products into a package whose price yields a higher margin
  • stop serving customers who demand low margins

Pricing Tips: Start High; Big Results from Small Changes – the list price is an umbrella. It allows room underneath for temporary promotions, but only if the list price is high enough so that margin remains even after the discount. The other idea is this: small price changes can make a huge percentage change in your bottom line. Customers ignore small changes, but if you understand your margins, you realize that a 10% price change could mean a 100% change in profits.

Pricing in a Job Shop: Setting the Shop Rate – avoid the two biggest mistakes: forgetting to include your target profit as one the “costs” your price must recover; and assuming all paid hours are also billable hours. The tip about small changes having big results applies here too!

Pricing Technique: Good, Better, Best – offer customers three levels of quality/service for three different prices. Customers like choice, and tend to buy more than the basic tier. Plus, three tiers shows a clear upgrade path to the risk-averse.

Pricing Technique: Value in Use – set your price according to how much your product saves the customers vs. their alternative. If you save him 10, charge him 5. Split the value with him. He’s thinking about his value, not your costs, so set your price based on what he is thinking about.

Price Structure Alternatives –  what are you charging for? Is it hours, or a finished project, a product unit or set, or the right to buy some (membership fee) or a right to use (subscription fee)? This article offers nine price structures with pros and cons for each, plus a few recommendations.

Differentiated Prices – who would happily pay more, and who would buy elsewhere for a lower price? You can charge different prices per customer group (e.g. students) or per location (e.g. resort) or by time (e.g. due date or show time). This article offers six bases for differentiation and situations for each.

Promotional Pricing – temporary discount programs can boost sales. The new customers may stay with you for years: what is their lifetime value (profit) to your company?  This article explains eight promotion types, but there are many more. Always test your promotion to see if the results are what you expect and are worth the discount.

Pricing to Distributors: What is a Reasonable Markup? – if the producer margin is only 15%, why does it make sense to expect a wholesaler markup of 20% and a retailer markup of 40%? Margin and markup are not the same thing. Wholesalers and retailers cover their costs out of their markup. As a producer, you must understand the retail price for your product, and the costs/value of your distributors. Your product’s value vs. competition sets this ceiling, and all the markups and margins work within the range of market price and producer cost.

Pricing is a fertile field. Readers surely have other techniques that work for them. Share them in a comment on this post!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

 

Pricing To Distributors: What is a Reasonable Markup?

by Tom Gray | on Apr 26, 2012 |  Comments

Distributors are the middle component of a three-tier distribution chain: producer to distributor to retailer. The distributor is the “middleman”. The distributor and the retailer incur their own costs in bringing the product to customers, and both need to recover those costs and earn adequate margins.

In setting their price to distributors , producers must understand both distributor and retailer functions and costs. Producers must also understand the ceiling on their product’s retail price level as dictated by product value and competitive alternatives.

For example, imagine a product priced at $100 retail. Potential pricing for a three-tier distribution model might be:

Cost

Markup

Selling Price

Manufacturer

$51.77

15%

$59.53

Wholesaler

$59.53

20%

$71.43

Retailer

$71.43

40%

$100

 

In this example, the manufacturer’s price to the wholesaler is 59.5% of the retail price. Let’s assume that the manufacturer’s cost includes an allocation of all his overhead, so his 15% markup is pure profit. The total markup by all three players is $48.33, or 92% of the manufacturer’s cost.

To allow “room” for markups by downstream players, the manufacturer must know the likely retail price. This is determined not by retailer whim, but by value to users relative to competition and their prices. See Pricing Technique: “Value in Use”.

Wholesaler markups average 20% and will not exceed 30-40%, according to The Average Profit Margin for Wholesale | Small Business – Chron.com.

For the retailer markup over what he pays the wholesaler, situations vary depending on the size and market power of the players, but a typical retailer markup would be at least 40% for big box retailers and more for boutiques. In this example the difference is 40%: (100 – 71.43 = 28.57) / 71.43 = .40.

Markup Is Not the Same As Margin!

In the example above, the retailer marked up the price 40%, but his margin was 28.57%. For markup, you divide profit by cost. For margin, you divide profit by price. See Pricing, Markup, Margins and Mass Confusion | Brooding on Matters | Travis T.[i]

Channel Margins Tool by Harvard Business School Publishing provides a handy online calculator for markup and margin in a four-tier distribution model.

Channel Functions Create Their Costs

The wholesaler’s price to the retailer determines not only the wholesaler’s markup – it also becomes the base for the retailer’s markup. Competition defines the retail price ceiling, so the retailer’s markup will be that market-determined retail price minus the wholesaler’s price. To understand what markup is fair for both players, you first must understand what value they are adding, and their related costs.

 

Wholesaler Functions

Retailer Functions

Buying the product

Buying the Product

Promoting/Contracting with Retailers to Sell It

Promoting/Contracting with Consumers to Buy It

Inventory Risks & Facility Costs

Inventory Risks & Store Costs

Assembling Product Assortments

In-store Merchandising

Sorting: Break down into small quantities

Shelving

Delivery to Retailers

Delivery to Customers

Financing Retailer Buys

Financing Customer Buys

Grading the Product

Handling Returns

Market Info Feedback to Manufacturer

Market Feedback to Wholesaler

 

Retailers have higher costs than wholesalers for their facility and for their advertising, promotions, and merchandising, while wholesalers have higher delivery costs.

In general, retailers have higher costs than wholesalers to perform their functions after they have purchased the product. This means retailers need a higher % markup between what they pay to buy the product and what they can sell it for. This markup is mostly used to cover their costs. Only a small percentage remains as a margin for their business.

Alternative: Cut Out the Middleman

At this point one or two players in the chain start to think about vertical integration. For example, the manufacturer considers whether he can deal with retailers himself, to save the wholesaler’s markup.

But here is a “word to the wise”: in doing so, you will have to perform the wholesaler’s functions yourself, so at best you would save the wholesaler’s margin, not the entire markup, most of which goes to covering his costs which you would then incur.

For an example of comparing channel costs, see Understanding the Economics of Your Product Distribution Channels : Money.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

 

Promotional Pricing

by Tom Gray | on Apr 25, 2012 |  Comments

Promotions are temporary. Promotional pricing is designed to provide a temporary boost in sales by offering more attractive terms than the standard list price and options.

Unlike differentiated prices (see Differentiated Pricing), promotional prices are available to all buyers, with the possible exception of a credit check for a promotion involving better credit terms. But the same question applies to both promotional and differentiated prices: are the additional sales worth more than the reduced margin per sale?

To answer this key question, companies always test their promotion. They introduce it for a narrow slice of the market or products, publicize it, track the additional sales, and assess whether any profit improvement resulted from the discount.

When testing, the same cautions apply: be sure to publicize the promotion; be sure to track it fully, and try to determine whether the customer would have bought anyway at the original price.

Types of Promotions

There may be as many types of promotions as there are stars in the sky! Owners design promotions according to market demand and product profitability, and the only limit is their creativity. Some examples are:

Promotion Type

Definition

Objective

Buy one get one free (BOGO) Two for price of one Increase unit sales; useful when production cost is a small % of total cost 
Loss leader Price below cost Attract new buyers to the product line; sell more high margin accessories or tie-ins 
Special Event pricing Limited time sale price Attract more buyers now who will return later and/or buy accessories or tie-ins 
Cash rebate Sell for list price but offer discount via cash back Maintain list price; offer appearance of a deal; reduce cost of discount by % of buyers who do not pursue the rebate procedure 
Low interest financing As stated Maintain list price; attract more buyers via lower monthly payment; Seller pays part of interest cost 
Longer payment terms or no payments until (delayed start) As stated Maintain list price; attract more buyers via lower monthly payment; seller may borrow working capital to replace delayed cash flow 
Longer Warranty As stated Maintain list price; attract more buyers by reducing their perceived risk; useful when most warranty issues occur early in the life of the product 
Free component (free razor; pay for blades) As stated Attract more buyers; useful when most margins result from sale of consumable accessory (blades) 

 

Promotion Cost vs. Lifetime Value

Promotions make financial sense when you consider the lifetime value of the customer to your business. It is worth incurring a cost (lower margin) to gain a customer who will make subsequent purchases that generate high margins. Examples are automobile servicing, blades for razors, e-book purchases vs. e-reader device, credit card interest, replacement parts, etc.

To do the math, you need to consider the cost and the gains. Costs include lost margin for those who would have bought anyway (eventually) and publicity costs. Gains include any margin on the original sale from those who would NOT have bought from you, plus the margin from their subsequent purchases, for as long as they buy from you.

How long does your average customer buy from you? For example, one credit card issuer calculated an average customer life of eight years. This issuer chooses promotions to gain new customers where cost of the promotion (such as a lower interest rate for the first year) is less than the total margins they earn from those new customers over the next seven years.

Do the math, run the test, redo the math after seeing results of the test, then launch the promotion or modify the offer, and test again.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Differentiated Pricing

by Tom Gray | on Apr 19, 2012 |  Comments

“Differentiated Pricing” means different prices for the same product in different situations. Familiar examples are senior discounts, high prices at airports and resorts, and lower prices for last-minute tickets.

The goal of differentiated pricing is to earn higher margins in one of two ways:

  • higher prices in a location with less competition (airport, resort, pro shop, entertainment venue)
  • lower prices whose lower margins are offset by producing enough additional sales to gain higher profits overall (last-minute sales of vacant rooms or cheap tickets)

For the small business owner, the challenge is to know the market well enough to be sure the differentiated price really does generate higher margins. Will that senior discount really draw more customers? At a movie theater, if popcorn costs less, how many more buckets would be sold?

Test It!

Like most other marketing initiatives, the best way to find out is to test. Try a differentiated price, publicize it, and see how many sales result. Ideally, you would also ask customers if they would have bought anyway at the old price.

A very common error in putting this “test it” advice into practice is failure to publicize: “we tried that for a week and got no uplift; no, we didn’t change our marketing – that would have cost too much.”  Do not test if you will not be telling customers about it!

Another common error is hit-and-miss recordkeeping about test results: “our afternoon clerk didn’t know he or she was supposed to tally or ask or offer….”

Common Price Differentiation Techniques

Basis for Differentiation

Situations with Special Prices

 

Customer Segment Discounts for Students; Seniors; Residents of taxing (e.g. park) district 
Product Form Ascending price per milligram for Sweetener box v. packets vs. tablets 
Channel of Distribution Ascending price for online vs. big box store vs. specialty store 
Location Higher price for spot with less competition (pro shop, airport, resort); lower price in outlet center 
Time Lower price for advance purchase; lowest price for last minute purchase of perishable good (to the hotelier, the most costly hotel room is the empty one) 
Geography Ascending golf fees for rural vs. urban vs. resort; lower cost plane ticket when flying from a low-income country

 

Do any of these fit your business? Why not try some out, and see the test results?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Price Structure Alternatives

by Tom Gray | on Apr 19, 2012 |  Comments

Your “price structure” is what you charge for (product or service component or package) and when the payment is due. For example, you might charge an hourly rate, or a package price for an entire job.

Your price structure should meet some or all of these goals:

  • more margin per unit sold
  • sell more units
  • obtain cash flow early enough to enable continued operations
  • ensure on-time payments
  • reduce customer resistance for reasons of credibility or fear of exceeding budget
  • reduce your risk of costs exceeding budget

Some common price structure alternatives used in different industries:

Technique/Example

Seller Pro/Con

Buyer Pro/Con

Per package, not per unit- Package of wood screws Pro: Sell more unitsCon: May need to discount the package price, e.g. price for package of 50 = price for 35 units bought individually

 

Pro: SimplicityCon: Am I paying for more screws than I need?
Per deal, not per hour- Consultant Pro: Customer has certaintyCon: Risk of poor estimate requires raising estimated hrs. by 10-20% to get basis for package price

 

Pro: Certainty for budgetCon: Am I paying for more hours than I am getting?
Per hour not to exceed x without customer OK- Consultant Pro: Customer has controlCon: No risk of underestimating Pro: Control for budgetCon: Control is imperfect — when consultant asks for OK to exceed, I will need to grant it for project to complete

 

Retainer plus price of excess units- Lawyer Pro: Covers setup time/cost; provides opportunity to develop relationship and prove value; customer decision at a lower price point makes it easier for him to say yesCon: Customer who would have paid high package price objects to “nickel and diming”

 

Pro: Smaller purchase before relationship is developedCon: No upper limit means lack of control, but customer can always say stop!
Base product price plus price for additional options- Car  Pro:  Simplicity in product package; sell more options than if they were ordered individually Pro: Simplicity of packageCon: Buy more options than needed
List price less various discounts- Insurance Pro: Discounted price makes customer feel good; manages price level to risk levelCon: Company may appear high-priced if only list prices are compared Pro: Discounts make customer feel like a wise shopperCon: Availability and amount of discounts not clear at outset

 

“Progress Payments” through the course of the work- Construction Pro: Match timing of cash received  to timing of expenses paidCon: Customer may resist paying before results received

 

Pro: Spread out paymentsCon: Cash is paid out before value is received
Discount for payment within 30 days Pro: Motivates timely paymentCon: Some clients pay late and take the discount anyway!

 

Pro: Discounts always welcomeCon: May wish to pay later
Late payment penalty for payment after due date Pro: Motivates timely payment; avoids late payers taking a discount as aboveCon: Collecting difficult, but message is sent even without collecting

 

Pro: NoneCon: Pressure to pay

 

Recommended techniques are:

  • Consultant price per hour up to a maximum,  requiring client approval to exceed it (balances risk of error in forecast, for both buyer and seller)
  • Base price for package of features, plus ”a la carte” charge for options
  • Progress payments: these can be crucial to keeping your business solvent!
  • Late payment penalty: avoids clients paying late but taking a discount anyway.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Pricing Technique: “Value in Use”

by Tom Gray | on Apr 11, 2012 |  Comments

“Value in Use” pricing means the price is based on the product’s value to the customer, not the manufacturer’s cost of production.  For example, if a normal saw blade is priced at $7, and you create one that lasts 4 times as long, the value to the customer of the long-life blade would be $28, aside from saving the time involved in changing blades. What price should you set for the long-life blade?

Assuming the blade-changing effort is minimal, you will want to set your price below $28, since that is the point where the customer is indifferent to one of your new blades vs. four of the old blades. A price level somewhere between $14 and $21 seems reasonable if there is no competition for your new blade. If you price it at $17, the buyer and the seller each take half the increase in value. The difference is large enough to get the buyer’s attention and make him consider changing his habitual purchase behavior.

Using $17 as a test price level, you can then consider your development costs and any production cost difference between the old and the new blade, to see the effect of this price level on your margins. The price you choose should be low enough that customers see significant value, but high enough to generate premium margins while leaving room for price cuts when competitors match your innovation.

Obviously, this is not “cost-based pricing,” and it is not “pricing to competition.” The price is based on the value to the customer who buys the long-life blade. Only after establishing that value do you consider your cost and potential competitive responses.

Provide an Upgrade Path

Many customers will quickly understand the higher value of the higher-priced long-life blade. But may not need this value yet. To widen the market, consider an upgrade path for those not yet ready to change.

To illustrate, we need to change our example. Consider a server equipped with new software enabling it to work so fast that it can do the work of four servers. You want to set prices for three customer groups:

1. Data-Hogs: Buyers who need to buy more than two servers.

2. Entrants: Those who think they need to buy only one or two servers

3. Upgraders: Those who already own one server, and then realize the need to add one or more new servers.

Assume the old server price is $10,000, and you decide to price the new hardware/software package at $20,000. This is great deal for data-hogs, and delivers high margin for the seller. Smaller data users, the other two segments, are attractive for their numbers and future growth, but $20,000 is a much higher price than your competitor offers for an old-style server adequate for their current needs.

The solution is to continue to offer your old server at $10,000, like the competition, but enhance its value vs. the competition by offering to equip it with the new four-times-faster software when the customer is ready. This is an upgrade path.

How would you price this software-only retrofit? The upgrade price should be more than $10,000, to avoid competing with your new server priced at $20,000.  It should be less than $20,000, because otherwise the customer who already has one server could just buy two more old servers from you or your competitor, and see no price difference. A reasonable price for the software-only upgrade would be 1.5 times the price of an old server: $15,000. 

This table summarizes a “value in use” pricing plan for this example:

Customer Need

1 Server

2 Servers

3 Servers

4 Servers

Today’s Customer Spends

10,000

20,000

30,000

40,000

New Data-Hog spends 20K: HW/SW package

20,000

20,000

20,000

20,000

Entrant spends 10-25K: HW + retrofit

10,000

15,000

 

 

Upgrader spends 15K: SW-only retrofit

 

15,000

15,000

15,000

 

Those who buy the package pay $20,000, while those who buy in two steps pay $25,000. Yet previous customers get the new technology for $5,000 less than new buyers, recognizing the value of the current customer base.

Offering the choice of a software-only upgrade sets a value for the software. Here is a side benefit. The retrofit choice actually defines the value of the package offer as a better deal: new hardware for half the old hardware price, plus growth at no cost.

By offering the upgrade as an alternative to the package offer, the seller is actually enhancing the perception of the package offer’s value. This is a good example of the “decoy effect” that results from offering different alternatives.  See Pricing Technique: Good, Better, Best.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

 

 

Pricing Technique: Good, Better, Best

by Tom Gray | on Apr 11, 2012 |  Comments

Three-tiered pricing is a popular and proven pricing technique. It goes by many names: good, better, best; economy, standard, premium; bronze, silver, gold; consumer, professional, expert, etc. The idea is to give customers a choice and a basis for comparison, but not choice overload – not a laundry list. See Product and Service Bundles: Product Strategy.

Offer Choice, But Make It Easy to Choose

Buyers appreciate choice. It shows that the seller respects them by responding to a variety of customer requirements and price ranges. Choice also gives buyers a basis for comparison, because it shows how the price changes when different features are added or subtracted. As a result, buyers can be comfortable they made a good buying decision because they bought only as much as they needed.

On the other hand, buyers do not respond well to choice overload. They expect the seller to anticipate some common sets of needs, and design packages to address them. Examples are all around us: software versions, car models, Olympic medals, etc. For some reason, the human brain is comfortable with sets of three. Even jokes often cite three situations, with the third containing the punch line!

Why Three Tiers?

Sellers like three-tier pricing too. First, it communicates everything they can do without requiring everyone to buy the premium package. Merely defining the premium package communicates the extent of the seller’s capabilities, earning credibility. Buyers who choose a lower tier still have the comfort that they can upgrade to a higher tier without losing their investment.

Second, three-tier pricing appeals to a wider market. It offers an affordable entry level, as well as the complete package for high-end buyers. Sellers can use the lower tiers to compete against discounters without risking a price war, while showing their capabilities to those willing to spend more to get more.

 Third, experience shows that more people choose a higher price alternative when three tiers are offered vs. two! This has been called the “decoy effect.” See We’re All Predictably Irrational – Dan Ariely – YouTube.

How To Do Three Tier Pricing

1. Establish three versions of your product, geared to three types of customers or three common sets of customer needs.

2. Find a way (often a table) to show at a glance which services fall into each tier. This enables customer to compare, as well as to understand the full extent of the seller’s capabilities. For an example, see Product and Service Bundles: Product Strategy | Thomas H. Gray – Consultant, CEO, Director.

3. Offer an upgrade path. Those who buy a lower tier should be able to see that they can customize by ordering additional services on an a la carte basis. This helps customers manage the risk of overbuying or underbuying, increasing their comfort level. However, the a la carte price is usually higher than if they bought some predetermined set of those services in the higher tier.

For a familiar example, think about buying a new car. Auto manufacturers offer three sets of features, packaging the options into manageable sets with three progressive price levels. If you want to add a feature a la carte, you can do so, but may have to wait for it to be built that way. To get your car right away, you can buy the higher feature set, or save a little by foregoing the desired feature and buying a lower level package or model.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

Pricing in a Job Shop: Setting the Shop Rate

by Tom Gray | on Mar 28, 2012 |  Comments

A “job shop” sells custom-made parts, produced according to customer specifications, usually in small quantities. Job shops develop a price quote for each job, rather than establishing a standard list price per product.

Their “shop rate” is a bundled price applied to billable labor hours (those spent on the job being quoted), designed to capture enough revenue to cover labor costs, overhead, and target profit. Setting the right “shop rate” is the key to their profitability.

This article provides the techniques for calculating a shop rate. For example, employees may earn $25/hour, but the company may need to charge its customers $75 to $100 per hour spent on a job, to recover overhead and profit as well as labor costs.

Step One: Estimate Costs and Target Profit

First, estimate the costs to be recovered by the shop rate for the coming year. For our example, we assume the following costs are passed through to the customer without markup: materials, subcontractors, shipping. This means the shop rate must recover labor, overhead, profit, and sales commissions.

Labor includes hourly wages (whether or not they are billable on jobs) plus benefits and related payroll taxes. Overhead includes the owner’s salary, benefits, and payroll taxes, plus fixed costs such as rent, utilities, insurance, maintenance, computers, vehicles, depreciation on equipment, etc.

Profit will be a dollar amount, not a % of revenue at this point, because revenue is unknown. Assume the profit target is an amount equal to the owner’s salary.

Sales commissions might normally be 5% of revenue, but we do not know revenue yet. Use one-sixth of salary plus overhead (excluding labor) as an estimate, based on the assumption that salary plus overhead will turn out to be 30% of revenue.

For this example, assume the following: owner’s salary is 50K; other overhead aside from labor is 100K; profit is 50K; sales commission is 25K; non-billable labor cost is 80K and billable labor cost is 120K. This assumes 60% of paid labor time is billable on jobs. The rest is setup/cleanup, training, paid time off, and miscellaneous. Thus the shop rate must recover 425K.

Step Two: Estimate Annual Billable Hours and Calculate the Shop Rate

Second, estimate the number of billable hours for the year. Billable labor cost of 120K less 10% payroll tax and 10% benefits leaves approximately 100K. Divide that by $25/hour to get 4000 billable hours.

The resulting shop rate is 425K / 4000 hours or $106.25 per hour. This is an illustration, not a recommended price! Your shop rate depends on your own numbers: overhead, salary, profit, wage rate, etc. However, note that it is not unusual for the shop rate to be 3 or 4 times the hourly wage rate.

Avoid Two Common Errors

One common error in calculating the shop rate is omitting the target profit. Another is assuming all paid labor hours are also billable hours.

Job shop owners should review their shop rate at least annually. The tip about small changes having big results (see Pricing Tips: Start High; Big Results from Small Changes) applies here as well: raising your shop rate by $2 may increase your profits by 20%. Use your own numbers, and check it out!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

 

Margin Analysis Drives Pricing

by Tom Gray | on Mar 28, 2012 |  Comments

You know your price must deliver enough margin, after variable costs, to cover overhead and leave the target profit you want. This means that margin analysis, i.e., understanding all your variable costs, is crucial to setting your price.

Variable costs are those costs whose amount changes with another sale. They include

  • materials
  • labor
  • subcontracted services
  • shipping
  • sales commission

Owners increase their margins, and hence their profits, by reducing these variable costs on a per product basis. For example, if I cut my variable costs from 55% of revenue to 50%, then my margin grows from 45% to 50%.

Margin Analysis by Product and Customer Group

Margin analysis gets bebeath the Buisness P&L, to assess the margin on each product and each set of customers.

Owners need to know which products have the highest and lowest margins. There may be a role for low margin products, to attract new customers, or fill a hole in the product line. But there may also be opportunities to raise those low margins by product or process redesign, or charging for shipping, or reducing sales commission for such products.

Why pay the same % commission on sales that generate a different % margin? You want salespeople to focus on selling high margin products, and a differentiated commission plan motivates that behavior.

A second technique is raising the price to achieve the desired margin. If it is not making enough money, why are you selling it? Consider using a series of small increases to get the price where it needs to be (see Pricing Tips: Start High; Big Results from Small Changes).

A third technique is to boost the prices and margins for products with little competition. For example, once the customer has bought the main item, you will have little competition for accessories and replacement parts. That means these can be priced with very high margins. One example would be a replacement battery for a laptop computer.

A fourth approach uses innovative bundling. In Know Your Sales Margins – Business Profit Margins | Entrepreneur.com, Randy Myers tells of a company who paired high and low margin products into an offer that produced a higher blended margin. He says “think fast-food value meals.”

Other examples of pairing low and high margin products would be maintenance contracts, or a discount on an already-high list price for replacement parts.

The other direction for margin analysis is looking at customer groups. Some types of customers cost more than others. Reasons may include their need for after-sales support, or warranty replacements, or a lengthy sales cycle, or custom ingredients or processing.

Managing your margins means controlling these extra costs, or charging more to cover them, or even “firing” these customers.

Profitability depends on knowing your margins by product and by customer group. Armed with that knowledge, business owners can focus on which costs to control, and choose prices that deliver their target margin and profit.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

 

Pricing Tips: Start High; Big Results from Small Changes

by Tom Gray | on Mar 16, 2012 |  Comments

For a new business or new product, the pricing mantra is “Start High”. For a business already in operation, you must understand the effect of a small price increase on your profit level.

Start High

“Start High” makes sense for these reasons:

 

  • Pricing is a game with several moves, including the competitor’s responses and your discounts. If you try to become the low price alternative, you will find the competitors matching you. Then what is your competitive edge? If you reduce your price further, the competitor may match your price. Then you are in a price war, which you will lose quickly if your price starts out low. You will not have enough margin to cover costs and meet target profit goals.

 

  • The list price is an umbrella, providing room for temporary promotions designed for a temporary boost in sales and hence revenue. A high list price provides enough profit margin to allow for special-purpose discounts and promotions that can still be profitable. If your list price is too low, your average price after factoring in discounts/promotions may be too low to meet your profit goals.

 

  • Price cuts are easier than price increases. If you find your price is too high for your sales goals, customers will always welcome various discount programs or even a reduced list price.  However, if you find your price is too low, increases must be carefully managed to avoid driving customers away.

Small Price Increases

The fastest way to increase revenue is to raise your price, but small business owners value their customers and are afraid that a price increase may drive them away. Fear not – instead, analyze!

  • Small increases can have a major effect on profits. Assume your price is $20 and your profit after overhead is 10% of sales or $2. A 10% increase in price would be $2, raising the price from $20 to $22, but this would double your profit to $4! A 10% price increase boosted profits 100%.

 

  • Small increases are accepted by customers who value your offering. Would you change suppliers for a $2 price bump? It may be 10%, but it is still only $2. How many people stopped using the Illinois Tollway when it nearly doubled prices? Not many, because it still offered value vs. slower alternatives. If your product cannot hold customers with a 10% price increase, find ways to increase the value customers find in your product (e.g. “open road tolling”), and then raise the price!

 

  • Regular (annual) small price increases have even less impact, because customers learn to expect them. This is the cable TV strategy. Expected changes are hardly changes at all. With annual increases, the amount can be as low as 2%. The best strategy couples regular list price increases with attractive introductory rates and loyalty reward programs. The high list price enables the discounts (which help attract and retain customers) without missing target profit goals.

If you are starting out, “Start High.” If you are in business, use regular small list price increases to maintain margins while offering targeted discounts for selective purposes.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.

 

Pricing Basics: Value Positioning and Margin

by Tom Gray | on Mar 16, 2012 |  Comments

The price you choose for your products is one of the strongest messages you can send. To use it well, you must decide both your value positioning and the minimum margin you need to meet your goals, before deciding your price.

Value Positioning

Positioning means “how the customer thinks of your company” – a mental image or identity that expresses your competitive edge, the benefit you offer. Your company offers some unique benefit which your target customers appreciate, one they prefer to get from you rather than other sources. Otherwise, you should not be in business! See Competitive Analysis and Differentiation: Be Different or Be Gone!

This benefit has value, which should be reflected in your price. If you offer more value, your price should be higher. For example, if your device seldom fails and you have the fastest repair turnaround time, you can charge more than a competitor whose unit fails more often, or who takes weeks to repair/replace a failed unit.

People do not always buy the lowest price alternative. People buy value—the best combination of features/functions and price.

  • They buy luxury cars, not just Chevys.
  • They buy bottled water even though tap water is free.
  • They buy cable TV even though national networks are free.
  • They buy their favorite brand even though it costs more.

Why? Because that brand meets their needs best within their price range. Their needs include more than raw functionality. The brand they choose will also meet their needs for style, social acceptance, their need to be sure the product will work as advertised, and others.

When setting a price, know what your customers value, and how you deliver that value better than competitors. Then set your price higher than those who deliver less value. If your offering has value, your pricing should communicate that. Having the lowest price merely communicates adequacy, not value.

Calculating Minimum Margin

Margin is the difference between the price you charge and your variable cost of production. Your price must provide enough margin to cover

  • variable costs (e.g. labor, materials),
  • fixed costs (e.g. rent, insurance), and
  • target profit.

The important point is to set the price high enough to recover more than the variable costs to make and deliver the product. You must collect enough to pay for overhead (fixed costs) and provide the target profit as well.

So you must know what your costs are before setting your price, and you must select a target profit, expressed as a percentage of revenue.

For example, if you want a 15% profit before tax, and your fixed costs are 30% of revenue, then your variable costs can be as much as 55% of revenue (100% – 15% – 30% = 55%). If variable costs are only 45% of revenue, then your profit is 25%, given fixed costs of 30% (100% – 45% – 30% = 25%).

The basic formula is target revenue  = variable costs / (fixed costs % of revenue + target profit % of revenue), or variable costs /.45 in the above example. This formula applies for one product, or for the company as a whole.

 

Value Positioning and Margin are the two basic considerations for pricing. In the next few articles Business Techniques in Troubled Times will explain a number of pricing techniques based on these two concepts, such as margin analysis, shop rate, good/better/best, value-in-use, various price structures, differential pricing, types of promotions, and  distributor margins.

Acknowledgement: this article draws on some material presented by Dennis Sester, Phil Grisolia, and the author in the SCORE Fox Valley Pricing Seminar.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.