Dec
02

Pricing For Profitability in a Tough Economy

Few decisions are more crucial to a small business owner than to decide how much to charge for their products or services.  It is even more critical in difficult economic times when demand slows and suppliers engage in a price war, undercutting each other as their priority shifts from making profit to paying the bills and staying in the game.

It is therefore quite an irony, that pricing is the least understood aspect of a business in the small business world.  Pricing is a science. It can be complex, especially in certain industries and market segments.  However addressing some of the fundamental questions coupled with a disciplined, systematic approach of measure and control goes a long way in achieving profitability for a business, even in tough times.

In a recessionary environment, many businesses engage in price war to grab a larger share of a shrunken pie to generate sales, even though that results in slim profit or even a loss. Since many business owners don’t have a handle on their numbers, they are oblivious of the impact their pricing decision has on the bottom line.  Their overriding consideration is cash flow.  Their  thought process is “this too shall pass” and when good times return, they can get back their pricing as fewer competitors remain in the market to compete with. Wrong Idea!!!

Generating revenue at a loss threatens the long term viability of the business. If the demand remains weak for a longer period the business will soon run out of capital and face extinction.  Face it, the good old days of borrowing and over spending by the consumer sector of the economy is over.  Anemic demand is here to stay, there will still be suppliers (those who manage to survive) and supply will still outstrip demand.

Additionally, aggressive discounting creates the perception of a commoditized product which leads to loss of pricing power in the long run. .

So what’s the solution?

First, some implications of the new realities:

  1. Pricing To Competition Is A Sure Recipe For Failure – there will always be someone who will undercut you if you are a “Me Too” player
  2. Offering differentiated product that have unique sales proposition is the only guarantee of survival.
  3. Business owners need to have a handle on their numbers – understand the price-profit relationship.

Pricing In Difficult Times:

Value-based pricing is the only key to a successful and sustainable business in tough times. It starts with the premise that a sale takes place when value meets price. Put simply, it means that the customer will pay a price commensurate with the perceived value of the product / services.

Since this pricing philosophy relies on value as perceived by the customer, it is critical that the product or service is unique and compelling and positioned properly.  In many instance the product or service may not be unique or special, but one can still achieve uniqueness buy focusing on the total offering.

In value-based pricing the emphasis shifts from the core product/service offering to the total customer experience.  The key is to find an angle, some corner, some combination of elements that makes the customer experience unique, relevant and compelling. It often requires some level of creative imagination to achieve the desired differentiation.

Starbucks charges a premium for their coffee by differentiating on the total customer experience, from taste of the coffee to how they are served and the environment the customers get exposed to when they walk in.  The online retailer Zappos has built a loyal customer base by delivering WOW through their service.

Setting the Price – From Concept to Execution

Arriving at the right price is an iterative process that starts with the end in mind i.e.  the targeted profit of the business.  Initial price is set subjectively at a level higher than the competition but not too high to be perceived as unfair by the market.  After observing the market response to the price, the price is tweaked and the corresponding volume of sales is observed. The test and measure exercise helps in arriving at the estimated price/volume combination that would generate the targeted profit.

Value based pricing is not an exacting science since the delivered value is in the eyes of the beholder. One shouldn’t expect the customers to automatically see and understand the value being provided.  The business owner should change clients’ mindset about pricing by putting the real value right in front of their eyes. Once they do that and assuming the total offering is better than that of the competition, the value-based priced offering will find a receptive audience.